What Property Can Be Depreciated?

Tangible assets that a company or individual owns and utilizes in their trade or business to create money are considered property that can be depreciated. These assets gradually lose value over time due to wear and tear, deterioration, or obsolescence.

Depreciation enables property owners to write off the cost of their assets by distributing the cost across the asset’s useful life and lowering annual taxable revenue. Depreciable property frequently includes things like buildings, office equipment, cars, and machinery.

Types of Property which can be depreciated

Depreciable property includes owned property, leased property (if ownership aspects are met), and cooperative apartments used for business. Calculating depreciation involves specific methods based on ownership and improvements.

Property you Own

The property owned by the owner is considered as a depreciated property even if it is subject to a debt.

Leased Property

You are only able to depreciate leased property if you maintain ownership aspects of the property.

Ownership includes:

1. The legal title to the property.
2. The legal obligation to pay for the property.
3. Responsibility for paying maintenance and operating expenses.
4. Duty to pay any property taxes.
5. Bearing the risk of loss if the property is destroyed, condemned, or loses value due to obsolescence or exhaustion.

This means you must bear the burden of the capital investment in the property. If you lease property for your trade or business or to generate income, you typically can’t depreciate the property’s cost since you don’t own it. However, you can depreciate any capital improvements you make to the property.

Cooperative Apartments

As a tenant-stockholder in a cooperative housing corporation, if you use your cooperative apartment for business or to generate income, you can depreciate your stock in the corporation, even though the corporation owns the apartment.

Here’s how to calculate your depreciation deduction:

Calculate the depreciation for all depreciable property owned by the corporation in which you have a right of tenancy or proprietary lease.

If you bought the cooperative stock after its first offering, calculate the depreciable basis of the property as follows:

1. Multiply your cost per share by the total number of outstanding shares, and also include any shares held by the corporation.
2. Add any mortgage debt on the property on the date you bought the stock to the amount from step A.
3. Subtract any mortgage debt not for the depreciable real property (e.g., the part for the land) from the amount calculated in step B.
4. Subtract any depreciation for corporation-owned space that can be rented but cannot be lived in by tenant-stockholders from the amount calculated in step C.
5. Divide the number of shares of stock by the total number of outstanding shares, also including any shares held by the corporation.
6. Multiply the result from step e by the percentage figured in step D. This is your depreciation on the stock.

Your depreciation deduction for the year cannot exceed the part of your adjusted basis in the stock of the corporation that is allocated to your business or income-producing property. You must reduce your depreciation deduction if only a portion of the property is used for business or income production.

Property used in income producing activity or business

Depreciation is deductible only for the business-use portion of property, including home offices and eligible containers, provided they have a determinable useful life exceeding one year.

Partial business or Investment use

You can only deduct depreciation on the portion of property used for business or investment purposes if it is also used for personal use.

Office in home

You can deduct depreciation on the portion of your house that is used as an office based on its business usage.

Containers

Containers for the goods you sell are often considered inventory and are not subject to depreciation. However, if the shipping containers you utilize have a lifespan of more than a year and meet the following criteria, you may depreciate them.

• Qualify as property used in your business.
• The containers do not pass to the buyer.

Property which has a determinable useful life

Your property needs to have a measurable useful life in order to be depreciable. This implies that it must be a natural object that ages, degrades, wears out, runs out of use, or loses value.

Property Lasting More Than 1 Year

In order for property to be depreciable, it needs to have a useful life that is much longer than the year it is put into service

What Causes Asset Depreciation?

Any business that has vehicles and equipment incurs significant costs related to fixed assets. These assets need to be changed after a given amount of time since they become outdated. To determine the recovery cost incurred on fixed assets throughout their useful lives, assets are depreciated. When an asset reaches the end of its useful life or needs to be sold, this is utilized as a sinking fund to replace it.

Depreciation lessens the tax burden because it is used to reduce taxable income. Depreciation is a non-cash item that has no bearing on your actual cash position or cash flow.

Which methods can you apply to depreciate your property?

For the most part, property must be depreciated using the Modified Accelerated Cost Recovery System (MACRS).

Formula to calculate MACRS = Cost basis of the asset x Depreciation rate.

Other methods of calculating depreciation include straight line depreciation method, unit of production method and the double declining balance method.

The following property cannot be depreciated using MACRS:

• Property that you used prior to 1987.
• Property used or owned in 1986.
• Intangible property such as patents, computer software, etc.
• Records, videotapes, and films.
• Property obtained by a corporation or partnership through a nontaxable transfer.
• Items that you have chosen not to include in MACRS.

When Does Depreciation Begin and End?

Depreciation begins when property is “placed in service” for business use and ends when the property is retired, sold, exchanged, or converted to personal use or scrap.

• Placed in Service: When a property is “placed in service,” it can be included in the list of depreciable assets. A property is referred to as “placed in service” when it is prepared and open for use by businesses. The property may or may not be used by the firm, but as soon as it is in the company’s possession, depreciation can be claimed.

• Company resources: Depreciation expense may be incurred on fixed assets utilized for business purposes or as a component of revenue-generating operations. When a fixed asset is “placed in service” of the company, it starts to depreciate.

• Idle Property: The depreciation will be deducted from the property used in your business or for the production of income even if it is temporarily idle. 

• Determinable useful life: The useful lives of the depreciable assets must be determinable. An asset’s useful life cannot be infinite since that would fall outside the purview of accounting.

• Minimum usable life: The minimum useful life of a depreciable asset must be more than a year.

• Assets used for business purpose: The amount of an asset’s cost that is utilized for business purposes is only subject to depreciation when it is part of a business asset.

• Owned assets: Fixed assets that are owned may qualify as depreciable resources. Depreciation is not allowed on leased or rental property.

The depreciation of the property stops when the property is retired from service. The property retires from the service when you permanently withdraw it from use in a trade or business or use in the production of income due to one of the following events:

• You exchange or sell the property.
• You transform the property to personal use.
• You leave the property.
• You move the property to a supplies or scrap account.
• The property is eliminated.

Conclusion

It is crucial for every business to recognize the significance of accurate tax filings, properly calculated depreciation and asset classification. To claim depreciation under Section 179 for listed property and property placed in service in a taxable year, taxpayers must fill out and include Form 4562 with their tax return.