Depreciation is a tax concept that is often misunderstood by taxpayers. What is it? It is the way that some items are required to be written off as expenses to reduce taxable income. Asset items used in your business are required to be deducted over what is considered their useful life as determined by the governments prescribed times. For example the useful life of computer and computer equipment is 5 years. This means that even though you purchase a computer this year for use in your business you are expected to depreciate or deduct that purchase a little each year over 5 years. Now this is a little tricky because there are various methods that can be used to do this depending upon how quickly you desire to receive the deduction. Some people who meet the income qualifications will choose to elect to take a Section 179 deduction which allows business assets to be deducted in their entirety in the year of purchase up to the annual specified limit; and some people choose to take the slowest method so they have the deductions in later years when they expect their income to be higher and perhaps taxed at a higher rate.
An important consideration that is very often overlooked is the fact that if you depreciate a business asset and then later sell that asset you may be subject to what are known as recapture rules that could trigger a gain on the sale of the asset and corresponding tax due on that sale. For this reason itís a good idea to discuss sales of business assets with your tax consultant beforehand to do appropriate tax planning related to potential gain due to depreciation recapture.
Depreciation is for tangible assets. Tangible assets are items with physical form generally that you can touch and see. For example a desk is tangible but a contract value or the value of an agreement (covenant) not to compete is intangible and therefore it is amortized not depreciated and subject to amortization rules.
Over the years Iíve often wondered if some employers actually think that their employees are depreciable assets. While I do believe that good employees are the most valuable asset of any business, they are not owned and therefore should not be depreciated. By this I mean that when employers overwork but under value and under pay their employees they are in effect using up their useful lives too quickly. Employee Burnout is an example of what happens to your assets when they are over depreciated too quickly. You end up with valuable assets devalued by making poor decisions related to depreciation and a lack of appropriate long term business planning. Clearly proper care and treatment of all business assets gives an employer the best possible value for their business investments.
As always I hope you are enjoying Tax Facts on the Taxing Subject of Taxes!
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