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It allows companies to spread out the cost of some expenses, reduce taxable income and manage long-term investments.
What Is Depreciation?
Assetslike equipment, vehicles and furniture lose value as they age.
Parts wear out, and pieces break, eventually requiring repair or replacement.
Depreciation helps companies account for the declining worth of their assets.
This strategy helps align assets with the revenue they generate for the business.
Depreciation impacts businesses in several additional ways.
Here are some of the most commonly used methods.
Straight-Line
This straight-line depreciation method evenly distributes the assets cost over its useful life.
It works well for assets like property that tend to depreciate predictably each year.
It typically results in higher depreciation in the early years and progressively lower amounts later.
It is often used for assets that lose value faster early on, such as vehicles or machinery.
The method applies the greatest rates during years when you use it most.
Accelerated depreciation enables businesses to takelarger deductionsearly in an assets life, reducing taxable income upfront.
This method is particularly useful for assets like technology, which lose value quickly.
For example, under MACRS, computers or machinery may be depreciated at a 200% declining balance rate.
This allows for higher deductions in the early years and improved cash flow for reinvestment.
Real Estate Depreciation Example
Say you purchase a rental property for $500,000.
you’ve got the option to depreciate the cost of the physical property.
If the value of the land is $50,000, you could depreciate the remaining $450,000.
However, you’re free to only use this as long as you still own the property.
Key Facts for Real Estate Investors
Depreciation vs.
Amortization
Depreciation and amortization both allocate the cost of assets over time.
However, they apply to different types of assets.
How To Calculate Depreciation: Step-by-Step
Takeaway
Depreciation helps manage the cost of long-term assets.
Its a helpful financial tool for business owners, real estate investors and accountants.
FAQ
Allison Hachecontributed to the reporting for this article.
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