Depreciation spreads the deduction for the cost of a long-term asset over its useful life, which the IRS considers to be three to seven years, at least for most business equipment and electronics. Rather than deducting the entire cost at once, you take the deduction in installments, according to one of several formulas accepted by the IRS. The depreciation rules are complicated; the IRS guide to the subject (Publication 946, How to Depreciate Property) is more than 100 pages long and is full of exceptions, limits, and traps for unwary deduction claimers. If you are required or plan to use the depreciation method, get some accounting assistance.
Does depreciation ever make sense?
Unless you buy more than $102,000 worth of business property in a single year, you’ll probably be allowed under Section 179 to deduct the costs of long-term assets in their year of purchase. So why would anyone ever choose to depreciate these costs?
Generally, they wouldn’t. In a couple of situations, however, spreading the cost of a capital asset over several years makes sense:
You need to show a profit. If you’re pushing up against the IRS’s hobby-loss rule (see the section Is eBay Your Hobby or Business?) in a particular year, you may need to show positive net income to prove you are really running a business, not playing at a hobby. Depreciation will decrease the deduction for an item for that year, which might mean the difference between a profit and a loss.
You expect to earn more in the future. If you expect to be in a higher tax bracket in later years, you might want to depreciate. Because the value of a tax deduction depends on your tax rate, a deduction will save you more in taxes if your earnings are higher.