Tax Depreciation Explained—Reduce Tax Bills (2024)

Depreciation can open doors to tax deductions that reduce tax bills by a significant amount. For small businesses, it could be a great way to have some control over taxes and save thousands of dollars.

It not only reduces taxes but also recovers the value that an asset loses over time. It encourages businesses to invest more and take it to the next level.

In this article, we will explain what tax depreciation is. We will explore which assets are eligible for tax depreciations. We will also take you through important IRS tax depreciation rules and principles to give you a complete idea.

What Does Tax Depreciation Mean?

Assets depreciate over time; their value decreases throughout their useful life because of wear and tear, age, and other reasons.

Businesses claim depreciation expense in tax returns to cover this loss. It is known as Tax Depreciation. It helps the business recover the asset's cost over the years of use.

Suppose a business invests $10,000 in buying machinery, and the machinery loses 10% of its value each year. In that case, the business is allowed to show $1,000 (10% of 10,000) as tax depreciation in the expenses each year until the machinery completes its useful life.

Businesses might benefit from tax depreciation by depreciating assets gradually over their useful life. They can also opt for Bonus Depreciation and Section 179 to reduce a significant or whole value in the first year.

What Assets Can Be Depreciated?

Only the tangible assets that are used in business operations can be depreciated over time. They include:

• Building
• Vehicles (Cars, Trucks, etc.)
• Machinery and Office Equipment
• Appliances (Computer, Printer, etc.)
• Furniture (Desks, Chairs, etc.)

Note: Land is a tangible asset that cannot be tax-depreciated because it has an indefinite useful life without wear and tear.

The asset must qualify for tax depreciation. There are certain rules by the IRS.

• The asset should have a loss of value over time.
• If it is a building or vehicle, the business must own it. It doesn't matter whether it is acquired with a loan.
• The asset should be used by the business for income-generating activities.
• It should have a determinable useful life, which means the years of service of the asset should be reasonably estimated.
• The asset should have a useful life of more than a year.

Certain assets do not qualify for tax deprecation:

• Assets that are disposed of within one year of useful life
• Sold and exchanged assets
• Assets converted to personal use

Understanding which assets can be depreciated and calculating the value is a bit complicated. A professional tax advisory is needed to reduce tax bills correctly through tax depreciation.

Section 179 Deduction

The assets of a business depreciate over time, and that's how their depreciation expense is claimed in tax returns.

However, it is also possible to deduct the entire cost in the first year. How?

The Section 179 deduction allows a business to deduct the entire cost of a certain property/asset when acquired rather than depreciating over time.

Suppose you have bought new computer systems for the office for $5,000. You can write off the whole amount to reduce taxes for the year.

But it is only allowed for eligible assets. Some of them are:

• Furniture
• Computers and software
• Machinery
• Equipment

As of 2024, the value of the deduction should be no more than $1,290,000. Tax depreciation encourages businesses to upgrade equipment, machinery, and other things to improve the business.

Bonus Depreciation

Bonus Depreciation allows businesses to deduct a significant portion of the asset value in the year it is acquired.

Instead of writing off a small value every year, a significant portion can be written off to reduce tax bills. But how much? Unfortunately, it is not that simple. Let's understand its history to know the percentage that can be deducted from taxable income.

Bonus Depreciation accelerates depreciation by increasing its value in the first year. After the Tax Cuts and Jobs Acts (TCJA), the value of bonus depreciation was affected significantly.

The bonus depreciation was fixed at 50% before TCJA. Which means companies can deduct half of the cost in the first year. After TCJA, the percentage was increased to 100%, which expired on 31st December 2022 but may come back online with proposed 2024 legislation. 

From 2023, the amount of bonus depreciation is decreased by 20% until it is fully phased out on 1st January 2027. With that being said, the percentage of bonus depreciation in 2024 should be 60%. However, The Tax Relief for American Families and Workers Act of 2024 has extended 100% depreciation for qualified property placed in service after 31st December 2022.

Businesses can take advantage of the bonus depreciation and deduct 100% of the cost from the taxable income. It is applicable to the eligible properties similar to Section 179 deductions.

Bonus depreciation and Section 179 must be used strategically with the help of a qualified tax advisor to enjoy maximum tax benefits.

Qualified Improvement Property (QIP)

Qualified Improvement Property (QIP) is another way to accelerate depreciation. It allows businesses to deduct the cost of improvements to the interior of the building used for the business.

The improvements include:

• Renovation of interior, such as walls and doors
• Plumbing systems
• Electrical systems
• HVAC systems
• Security systems, etc.

Businesses can get tax benefits with QIP. Normally, a building is depreciated over 39 years by law. By using QIP, businesses can go with the 15-year straight-line depreciation. It increases the value of depreciation.

Note: Straight-line depreciation is a method for calculating depreciation. It evenly distributes the depreciation value throughout the useful life. The value of depreciation will be the same for all years.

Businesses can also opt for bonus depreciation to deduct the 100% cost of the improvements. It is essential to consult a tax advisor to select the right method for maximum benefits.

Want To Benefit from Tax Depreciation?

Tax Depreciation requires a close examination of the assets, taxable income, and the latest IRS guidelines to gain maximum deduction benefits. These are a bit complicated and require professional tax advice.

FCF Consulting Partners specializes in strategic planning and management of tax. We create custom plans according to the business and implement them throughout the year for maximum savings. 

Contact us to book a free 30-minute tax strategy session.

‍