Depreciation Definitions

Depreciation

Depreciation is a decrease in value due to wear and tear of the asset. For accounting purposes this can be taken as an expense to fixed assets. Inventory, stock in trade, land, and art work cannot be depreciated. Intangible items such as Goodwill cannot be depreciated, but they can be amortized over 15 years.

Tax depreciation - Most income tax systems allow a tax deduction for recovery of the cost of assets used in a business or for the production of income.

 

What is a Fixed asset?

It is also known as a non-current asset or as property, plant, and equipment (PP&E), is a term used in accounting for assets and property which cannot easily be converted into cash. This can be compared with current assets such as cash or bank accounts, which are described as liquid assets. In most cases, only tangible assets are referred to as fixed.

 

Amortization

Amortization is to periodically write off as an expense, a portion of the cost of an asset. Usually an intangible asset is amortized. Property that may be amortized include Pollution control facilities, Certain bond premiums, Research & experimental expenditures, Cost of acquiring a lease, Business start-up cost, Organizational cost for a business, and Goodwill.

 

Conventions

Half-Year - When the half-year convention is applied, a half-year of depreciation is taken for the first year the asset is placed in service regardless of what month the asset was placed in service. A full year's depreciation is taken each year for the remainder of the useful life of the asset. If the asset is disposed before the end of its useful life, a half year of depreciation is taken for the year of disposal regardless of the month in which the asset was disposed. If the asset is kept for the asset's entire useful life, half a year of depreciation is taken in the year following the last year of its useful life.

Mid-month - This convention only applies to residential rental property, nonresidential real property, railroad gradings and tunnel bores. The asset is considered to have been placed in service in the middle of the month and a half a month's depreciation is calculated for the month the asset is placed in service. If an asset is disposed before the end of its useful life, it is considered to have been disposed in the middle of the month and half a month's depreciation is calculated for the month in which the asset is disposed.

Mid-Quarter - When this convention is applied, depreciation is calculated as if the asset was placed in service or disposed at the mid-point of the quarter. For example, if an asset were placed in service in January, depreciation would be calculated as if the asset had been placed in service in the middle of February, the midpoint of the first quarter.

Generally, any property placed in service during the course of a year receives a half-year's depreciation under the half-year convention. However, a special rule applies if you place in service more than 40% of the total basis of property for the year in the last quarter of your fiscal year. That's to avoid waiting until the end of the year to buy the property, yet secure a deduction for the whole year. When calculating the total basis of property placed in service, exclude any on which you took the Section 179 expense election. For real estate, a mid-month convention is used.

 

Depreciation Methods

Double Declining - 150% or 200 % Method. Most of the depreciation is taking at the beginning of the asset's life.

Straight Line - Cost divided by the asset's life. This method is usually used for book depreciation.

ADS - Alternative Depreciation System, the depreciation is figured the same, as MACRS except the straight-line method is used, over the ADS recovery period, with the appropriate convention.  Instead of MACRS you can make an irrevocable election with respect to any classification of property for any tax year to use ADS. For residential rental and nonresidential real property, you may make this election separately for each property.

MACRS - The Modified Accelerated Cost Recovery System is the current tax depreciation system in the United States. Under this system, the capitalized cost is recovered over a specified life for depreciation. These lives are specified by IRS in tables where the assets are grouped into classes. MACRS uses either declining balance switching to straight, line or straight line to calculate the depreciation.

 

Listed Property

This includes automobiles, certain other vehicles, cellular phones, certain computers, and property used for entertainment, recreation, or amusement.

 

Salvage Value

This is the remaining value of an asset after it has been fully depreciated.

 

Section 179

This allows a taxpayer to deduct the cost of certain assets as an expense, rather than requiring the cost of the property to be capitalized and depreciated.  There is a dollar limitation on the amount that can be taken each year. This limit varies from year to year. See Section 179 Limits table. The 179 deduction for any taxable year may not exceed your income for that year; also there is a threshold dollar limitation.

 

Auto Limits

There are limits on the about of depreciation that can be taken each year for luxury automobiles. See Auto Limits Table

 

Depreciation Bonus

This special allowance is a deduction equal to 30, 50, or 100% of the depreciable basis of the qualified property. You figure the amount of the special depreciation allowance after any section 179 deduction you choose to claim, but before figuring your regular depreciation deduction under the Modified Accelerated Cost Recovery System (MACRS). The 100% special depreciation allowance applies to qualified property acquired after 9/8/2010 and placed in service before 1/1/2012.

Business Percent

This is usually used for MACRS, Listed or ADS depreciation methods.  This is the percent a car, computer, entertainment property, or cellular telephone is used for business purposes versus personal usage.  If the listed property business percent is 50% or less the ADS depreciation method is required instead of MACRS.

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