What Is Depreciation and Why It Matters for Small Businesses
When you buy business assets like equipment, vehicles or buildings, you usually can’t deduct the entire cost in the year of purchase. Instead, depreciation allows you to spread that cost over the useful life of the asset, matching the expense to the time the asset helps generate income.
Why Depreciate?
- Matches the cost of an asset to the period it benefits your business
- Reduces taxable income annually, lowering your tax bill over several years
- Provides a clearer picture of your business’s true financial performance
Common Depreciable Assets and Useful Life Examples:
Office furniture Desks, chairs, filing cabinets- 7 years
Computers and electronics, Laptops, printers, servers- 5 years
Vehicles Company cars, trucks, SUVs- 5 years
Machinery and tools, Manufacturing equipment, heavy tools- 7 years
Commercial office building- 39 years
Land improvements, Fencing, parking lots- 15 years
Types of Depreciation and How They Apply:
- Straight-line depreciation: Provides equal deductions each year over the asset’s useful life. Often used for buildings and office furniture.
- Accelerated depreciation (such as double-declining balance): Allows larger deductions in earlier years, useful for assets that lose value faster like computers or vehicles.
- Section 179: Lets you deduct the full cost of qualifying property (up to annual limits) in the year it’s placed in service. This deduction is often used for equipment, vehicles and certain software. The 2025 Section 179 limit is $1,220,000, with a phase-out beginning at $3,050,000 in total equipment purchases. Section 179 is especially helpful for small businesses that want to lower taxable income right away. Note that not all property qualifies, and business-use requirements apply (generally more than 50% business use). Heavy vehicles (over 6,000 pounds gross vehicle weight) often qualify for larger immediate deductions under Section 179. Any unused Section 179 deduction can be carried forward to future years if your business doesn’t have enough taxable income to use it all in the current year.
- Bonus depreciation: Allows a large percentage (often 100%) of the cost of qualifying assets to be written off in the first year. Can be combined with Section 179 in some cases.
Deductions and Income Types:
- Depreciation deductions can offset ordinary business income, reducing the tax you owe on profits.
- Certain types of depreciation, like those on rental properties, apply against rental income.
- If deductions exceed income, you may generate a net operating loss, which can sometimes be carried forward to offset future taxable income.
Carryover Rules:
- Section 179 limits may create unused deductions that can be carried forward to future years.
- Net operating losses from depreciation-related deductions can typically be carried forward to offset future income.
- Bonus depreciation generally applies fully in the first year but unused losses related to it may contribute to a Net Operating Loss (NOL) that carries forward.
Sample Depreciation Calculation:
Suppose you buy office furniture for $7,000.If you use straight-line depreciation, you divide the cost evenly over 7 years.
$7,000 ÷ 7 = $1,000 deduction per year.
If you qualify for Section 179, you could deduct the entire $7,000 in the first year instead. This can help lower your tax bill right away. Always check with a tax professional to be sure you’re using the right method for your business.
Final Thought:
Depreciation is more than just a tax break; it’s a tool for managing your business’s financial health. The right strategy can lower taxes, improve cash flow and align with long-term goals. Always work with a tax professional to choose the best approach for your business.
