What Business Owners Need To Know About Depreciation
Depreciation is an annual tax deduction that allows small businesses to recover the costs of certain property that decreases in value over its lifetime. It's an allowance for the wear and tear, deterioration, or obsolescence of the property.
As a business owner, you can depreciate property when you place it in service for use in your trade or business or to produce income. You stop depreciating property when it has fully recovered its cost or when it's retired from service, whichever happens first.
Machinery, equipment, buildings, vehicles and furniture that are owned by the business. You cannot claim depreciation on personal property. If you use an asset — a car, for instance — for both business or investment and personal purposes, you can depreciate only the business or investment use portion. Land is never depreciable, although buildings and some land improvements may be.
To depreciate property, your business must:
- Own the property. The business is considered to own property even if the property is subject to a debt.
- Use the property in a business or income-producing activity. If your property is used to produce income, the income must be taxable. Property that's used solely for personal activities can't be depreciated.
- Be able to assign a determinable useful life to your property. This means it must be something that wears out, decays, gets used up, becomes obsolete or loses its value from natural causes.
- Expect the property to last more than one year. The property must have a useful life that extends substantially beyond the year you placed it in service.
- Not depreciate excepted property. Excepted property includes certain intangible property, certain term interests, equipment used to build capital improvements and property placed in service and disposed of in the same year.
Consider the Methods
The IRS allows you to use different depreciation methods, depending on the type of property.
The modified accelerated cost recovery system is used to recover the basis of most business and investment property placed in service after 1986. MACRS consists of two depreciation systems, the general depreciation system and the alternative depreciation system. Generally, these systems provide different methods and recovery periods to use in figuring depreciation deductions.
Sometimes, however, you will use the straight-line method, which lets you deduct the same amount of depreciation each year over the useful life of the property. There is also the forecast method, in which each year's depreciation deduction is equal to the cost of the property multiplied by a fraction. The fraction is the current year's net income from the property over the anticipated net income that the property will bring in 10 years after it is placed in service.
New for 2022
There have been several depreciation updates for 2022, including:
- Bonus depreciation deduction for property improvements was increased from 50% to 100% and will be available through the 2022 tax year. It will then gradually decrease until it expires at the end of the 2026 tax year.
- The depreciation limits and inclusion amounts for passenger automobiles that a taxpayer first places in service or first leases during calendar year 2022 have increased.
- The 2022 Section 179 deduction limit for businesses is $1,080,000 (a $30,000 increase from 2021). The spending cap on equipment purchases for 2022 is $2.7 million.
- For the self-employed and small business owners, the amount you can save in a SEP IRA or an Individual 401(k) goes up to $61,000 in 2022, a $3,000 increase.
- If you are self-employed, you may be able to deduct the money you spend on health insurance premiums for yourself, your spouse, and even your dependents.
- Standard mileage rate increased to 58.5 cents per mile driven for business use, up 2.5 cents from the rate for 2021.
There are many deductions a business owner can take. This is just a short list. Your best bet is to work closely with MHCS to make sure you're getting all the breaks you're entitled to.