Depreciation is a way you are allowed to deduct the normal wear and tear of business assets (equipment, computer software, automobiles, office furniture, etc). You may claim an item which: you use in your business, wears out over time, AND has a useful life exceeding one year. Because the item is expected to wear out over time (longer than one year), time frames have been assigned to different classes of items, depending on how long that item is expected to be useful in your business. These time frames are called classifications or class life.

Some common classifications:

3 years: off the shelf computer software

5 years: cars, trucks, trailers, computers and peripherals, copiers, calculators

7 years: office furniture, fixtures, unclassified personal property

When depreciating an item, you will need to choose both one method and one convention.

Methods:

Declining Balance

The General Depreciating System (GDS) is the standard, accelerated method of depreciation under MACRS. Using the GDS 200% declining balance (200DB) method (150% for 15 and 20 year property) means you get to deduct more of the value of the item in the early years of its recovery period.

Straight Line

The Straight-Line (S/L) method of depreciation allows you to deduct the value of your item equally over the recovery period.

Alternative Depreciation

The Alternative Depreciation System (ADS) uses the straight-line method of depreciation over a specified number of years. The recovery period for ADS is usually a little longer than used under general or straight-line depreciation methods. (Comparison charts found in the book.)

Choosing a Method

The year you purchase and put your item into use in the business is generally the first year you will take depreciation deductions. That first year is when you will choose what method of depreciation to use. It is standard to use the GDS 200% declining balance method for computing most of your business property. Sometimes, however, you are required to use a different method (usually when business usage is 50% or less on listed property).

You may generally elect to use either the ADS or Straight-Line method for business assets, instead of an accelerated method. The catch to doing so is you must make that election for all property of the same class life put into use in the same year.

-Example: If Morgan made the election to depreciate her office desk (7 year property) using the straight-line method, she would also have to use the straight-line method for all other 7 year property purchased and put into use in the same year.

Once you choose a depreciation method, you need to stick with it for that particular item until it is fully depreciated (unless you are required to change, as with business usage dropping to 50% or less).

Listed Property

In order to use an accelerated method of depreciation for listed property, you must use the equipment more than 50% for business purposes. If you use the item 50% or less for business purposes, listed property must be depreciated using the Alternative Depreciation System.

If you initially use your listed property over 50% for business, but then in drops in a later year, previous accelerated depreciation deductions are subject to recapture. The amount recaptured is the amount previous deductions exceed the depreciation that would have been allowable under ADS.

Simon Elisha, author, Taxes for Online Sellers-
A How-To Guide for Individuals on Federal Tax for Internet Sales
ISBN: 978-0-9796328-0-8
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Copyright 2007 -2008