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Understanding Depreciation

Lower your tax liability with this asset calculation

DAVID MILLS, O.D., M.B.A.

As time passes, assets, such as diagnostic equipment, lose value due to wear and tear. Depreciation is a tax deduction that allows a business to recover the initial costs paid for an asset. It is captured on the profit and loss statement as an expense that lowers the reported net profit of the business. That leads to a lessened tax liability.

Here, I discuss the criteria for depreciation and how to calculate it.

Meeting criteria

Certain criteria must be met for an asset to be depreciated:

1. The business must own the asset in question.

2. The business must use the asset in an income-producing activity. For example, if you use your personal car for business, only the percentage of business use can be depreciated.

3. The asset must have a useful life of more than one year.

Some non-tangible assets can also be depreciated. Examples: Any goodwill you paid when purchasing a practice or any copyrights you own.

Calculating depreciation

Determine the TOTAL acquisition cost of the asset, including the cost of the equipment plus other fees, such as shipping, associated with setup. From this, subtract the salvage value, or what you would expect the asset to be worth at the end of its “life.” (What do you think you would be able to resell the asset for? In many instances, the salvage value may be zero!)

Next, divide by the useful life of the equipment. Different assets have different values for useful life. The IRS has a schedule that assigns a useful life value to each type of asset.

Let’s say you purchase a piece of equipment for $50,000. After you add shipping and setup fees, the total is $52,000. Then, subtract the salvage value, in this case $4,000, leaving you with $48,000. You determine the useful life as 10 years. Therefore, $48,000 divided by 10 years would give a depreciation expense of $4,800 per year for 10 years.

Methods of depreciation

The above example illustrates straight-line depreciation, meaning the same amount of depreciation expense is taken each year until the useful life of the asset is reached and the total acquisition costs have been recouped.

This does NOT mean you can no longer use the asset in the business; it means the asset can no longer be depreciated.

However, depreciation can also be accelerated. This means that a larger deduction is taken in the first few years of the asset’s useful life. An example would be Section 179 expenses. The amounts of depreciation allowed change each year and are set by the federal government.

To make matters more confusing, your state may have different rules than the federal government uses on how depreciation may be calculated. This may cause an asset to be depreciated using two different methods — one for the state tax calculation and the other for federal.

Costly calculations

Any calculation regarding depreciation can have a significant impact on your tax liability. Always consult your accountant, and together determine which is the most financially sound decision to make. OM

DR. MILLS PRACTICES AT OCEAN STATE EYE CARE IN WARWICK, R.I., AND HOLDS A M.B.A. FROM PROVIDENCE COLLEGE. E-MAIL HIM AT MILLSD@NECO.EDU, OR SEND COMMENTS TO OPTOMETRICMANAGEMENT@GMAIL.COM.