Accelerated Depreciation is an important concept for business owners to understand. While it is fairly complicated, and the details and tax implications should be left to an attorney or CPA, you (the business owner) should have an understanding of accelerated depreciation and how you can save on taxes by using it.
First, review the concept of depreciation, which spreads the expenses of an asset over its useful life. Ordinary (un-accelerated) depreciation is also called "straight-line" depreciation, because the depreciation expense is the same each year. For example,if an asset is purchased for $10,000 and its useful life is 10 years, under straight line depreciation, $1,000 would be expensed in each year.
But the useful life of many assets doesn't follow a straight line. So the IRS allows accelerated depreciation, which puts most of the expense of the asset in the first years it is used. Depreciation on autos, for example, is accelerated. Section 179 deductions are an example of accelerated depreciation provisions set up by the U.S. government to encourage expenditures on capital assets.
Section 179 Deductions and Bonus Depreciation
In recent years, two types of accelerated depreciation have been allowed by U.S. law. These ways to accelerate deductions on business asset purchases are:
- Bonus depreciation is set up to allow a 50% bonus on the amount of expense allowed in the first year a NEW (not used) business asset is put into service (used).
- Section 179 deductions are set up similarly to bonus depreciation but they can be on used equipment or vehicles.
There are annual limits on bonus depreciation and Section 179 deductions, and those limits change each year. Congress sets the limits with changes to legislation, and the president must approve those changes.
Two ways to accelerate depreciation
The two most common methods of accelerating depreciation are "sum of the years digits" and "double declining balance." Here is (briefly) how each works:
- Under double declining balance, the asset is depreciated twice as fast as under straight line. Using the example above, 10% of the cost is depreciated each year using straight line. Doubling the rate would mean that 20% would be depreciated each year, so the asset would be fully depreciated in 5 years, rather than 10.
- Under sum-of-the-years-digits, the asset is depreciated faster than straight line but not as fast as declining balance. As an example of how this method works, let's say an asset's useful life is 5 years. Adding up the digits would be 5+4+3+2+1 or a total of 15. The first year, 5/15 is expensed; the next year 4/15 is expensed, and so on. So if the asset's cost is $1000, 5/15, or $333.34 would be expensed the first year, $266.67 the second year, and so on.
There are other accelerated depreciation methods, but these are the most common.
The IRS currently requires businesses to use the MACRS system for accelerated depreciation, in which asset classification determines the depreciation period.
This article, and the information on this Guide Site, is intended for general information only. The author is not a CPA, tax attorney, or Enrolled Agent. Consult with your tax professional for information relating to your specific situation.
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