Some explain depreciation to me

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cheese9988

Senior Member
VIP
Lets say a company buys a bridgeport for $10k and depreciates this over ten years. That's $1000/year. But what does this actually mean? Does this typically go against a companies P&L? Or is it simply a tax thing? I understand that the resale value goes down over time.
 
http://www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/A-Brief-Overview-of-Depreciation

A Brief Overview of Depreciation
Depreciation is an income tax deduction that allows a taxpayer to recover the cost or other basis of certain property. It is an annual allowance for the wear and tear, deterioration, or obsolescence of the property.

Most types of tangible property (except, land), such as buildings, machinery, vehicles, furniture, and equipment are depreciable. Likewise, certain intangible property, such as patents, copyrights, and computer software is depreciable.

In order for a taxpayer to be allowed a depreciation deduction for a property, the property must meet all the following requirements:

  • The taxpayer must own the property. Taxpayers may also depreciate any capital improvements for property the taxpayer leases.
  • A taxpayer must use the property in business or in an income-producing activity. If a taxpayer uses a property for business and for personal purposes, the taxpayer can only deduct depreciation based only on the business use of that property.
  • The property must have a determinable useful life of more than one year.
Even if a taxpayer meets the preceding requirements for a property, a taxpayer cannot depreciate the following property:

  • Property placed in service and disposed of in same year.
  • Equipment used to build capital improvements. A taxpayer must add otherwise allowable depreciation on the equipment during the period of construction to the basis of the improvements.
  • Certain term interests.
Depreciation begins when a taxpayer places property in service for use in a trade or business or for the production of income. The property ceases to be depreciable when the taxpayer has fully recovered the property’s cost or other basis or when the taxpayer retires it from service, whichever happens first.

A taxpayer must identify several items to ensure the proper depreciation of a property, including:

  • The depreciation method for the property
  • The class life of the asset
  • Whether the property is “Listed Property”
  • Whether the taxpayer elects to expense any portion of the asset
  • Whether the taxpayer qualifies for any “bonus” first year depreciation
  • The depreciable basis of the property
The Modified Accelerated Cost Recovery System (MACRS) is the proper depreciation method formost property. Additional information about MACRS, and the other components of depreciation are in Publication 946, How to Depreciate Property.

A taxpayer must use Form 4562, Depreciation and Amortization, to report depreciation on a tax return. Form 4562 is divided into six sections and the Instructions for Form 4562 contain information on how, and when to fill out each section.
 
Think about EBITDA

Earnings, Before Interest, Taxes, Depreciation, and Amortization.

As your assets age, in theory, they lose value while in service. If you have a 10 year depreciation, you lose $1,000 each year. After 10 years, you can throw it away or sell it. If you sell it, you log the value on your business "t-chart". If you sell for more than you claimed in depreciation, you must register that as a gain.
 
So this this is just a tax deduction to recoup the value of your inventory?
 
So this this is just a tax deduction to recoup the value of your inventory?

not inventory. inventory is your goods for sale. the correct term is "assets". anything you use for your business can accumulate depreciation. computers, cars and trucks, desks, tooling, cameras, etc. anything else goes into cost of goods sold or g&a (general and administration) expenses.
 
picture a T-Chart. when you spend cash on assets, your business is worth the same amount, you just have assets instead of cash. each year you accumulate depreciation, the loss of value in your goods. on the other side of your t-chart is the depreciation.
 
depreciation is a way to take the expense for a large purchase over the assets useful life.
1000/year would be straight line depreciation
there are many methods of depreciating an asset besides straight line, depending on how you want it to affect your bottom line in any specific year
depreciation expense comes off the P&L
 
If I spend $10,000 on a piece of equipment, and write off the $1000 in depreciation each year, isn't the IRS essentially slowly paying me back for that equipment over the 10 years?

EDIT: Part of that equipment, not all of it.
 
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If I spend $10,000 on a piece of equipment, and write off the $1000 in depreciation each year, isn't the IRS essentially slowly paying me back for that equipment over the 10 years?
No, you are reduced $1000 taxable income, not the actual dollar amount of taxes you pay. If you are in a 20% tax bracket, you save yourself from paying 20% of $1000 in profits. So you pay $200 less dollars in taxes.
 
No, you are reduced $1000 taxable income, not the actual dollar amount of taxes you pay. If you are in a 20% tax bracket, you save yourself from paying 20% of $1000 in profits. So you pay $200 less dollars in taxes.

Oops I meant they're paying for a percentage of the equipment, not the whole thing. So I pay $2000 less than I would have over 10 years, meaning the equipment really cost me $8000.
 
Correct. and if you sell for any amount more than you depreciated, uncle sam takes that as a gain. :D
 
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