Depreciation is a non-cash expense that reduces the value of an asset over time. Assets depreciate for two reasons:
- Wear and tear. For example, an auto will decrease in value because of the mileage, wear on tires, and other factors related to the use of the vehicle.
- Obsolescence. Assets also decrease in value as they are replaced by newer models. Last year's car model is less valuable because there is a newer model in the marketplace.
Depreciation is calculated as follows:
- The original cost of the asset, including costs of acquiring the asset, transporting it, and setting it up
- Less the salvage value (the "scrap" value)
- Divided over the years of useful life of the asset.
Depreciation is determined by one of several methods approved by the IRS.
For more information, see IRS Publication 946: How to Depreciate Property.
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