, Answering FAQ'sTurboTax Employee
Depreciation assumes that assets used to generate business income will wear out, get used up, or become increasingly obsolete over a period of time. For taxation purposes, depreciation lets you deduct the "used up" portion of that asset's cost every year, until the entire cost is used up or the business no longer owns the asset.
With one notable exception (Section 179), depreciation is required for "big ticket" business assets that have a useful life of more than a year and wear out over time, such as manufacturing equipment, computers, vehicles, and tools. Don't depreciate low-cost items like office supplies, even if they last more than a year.
Depreciation is sometimes called capitalization, cost recovery, amortization, or expensing. (To keep things simple, we'll stick with depreciation.) Here, we provide an overview of depreciation as well as TurboTax instructions. Refer to IRS Publication 946, How to Depreciate Property if you require more detailed, in-depth information.
Not all assets are depreciable, and different types of assets are depreciated using different methods.
Business assets must meet three conditions to be depreciable:
- They are used to produce income, rent, or royalty for a business. (Exceptions may apply for assets that failed to produce income, although that was their primary purpose.)
- They wear out, decay, becomes obsolete, or lose value over time.
- They have a useful life that is measurable and longer than one year.
Examples of assets you can depreciate include:
- Office furniture
- Cash registers
Intangible assets such as goodwill or trademarks and patents may also qualify for a deduction through intangible amortization.
Examples of assets you cannot depreciate include:
- Leased property
Determining the useful life of a business asset
The IRS places business assets in an asset class and assigns a useful life (called a recovery period) to each asset class. For example, office furniture belongs to an asset class that has a useful life of 7 or 10 years, depending on the depreciation method. For complete information, see Appendix B - Table of Class Lives and Recovery Periods which near the end of IRS Publication 946, How to Depreciate Property. TurboTax Business takes care of asset classes and recovery periods for you.
TurboTax Business calculates the depreciation amount for the current tax year and provides you with a summary of your depreciation deductions.
In addition, TurboTax Business:
- Prepares a separate Asset Entry Worksheet for each asset you enter.
- Gives you the option of claiming a first-year expense or section 179 deduction, when you indicate that your asset was placed in service during the current tax year.
- Transfers your depreciation information to Form 4562: Depreciation and Amortization (to include with your return) and Form 4562 Depreciation and Amortization Report (to keep for your records and use when preparing future-year tax returns).
- And last but not least, it automatically transfers your depreciable assets to next year’s return so you don't have to enter them again.
Here's how to enter a depreciable asset in the TurboTax Business product:
- In TurboTax Business, click the Federal Taxes tab, then click Deductions below it.
- At the top of the Your Deductions screen, click the Start/Edit button to the right of Assets and follow the on-screen instructions.
- If you've already entered an asset, you'll be taken to the Business Asset Summary screen. Here, you can either Edit an existing asset or enter a new one by clicking the Add Another Asset button.
When a depreciable asset is sold, bartered, discarded, or destroyed, report the transaction on your tax return. The amount you report is based on the original cost (basis) of the asset, accumulated depreciation, the amount of money or value you received in exchange for the asset, and any expense incurred in selling or disposing of the asset.
To enter the sale of a depreciable asset in TurboTax Business:
- Click the Federal Taxes tab, and then click Income right below it.
- In the Dispose of Business Property section, click the Start button to the right of Business property/assets.
- Follow the on-screen instructions.
TurboTax Business will display a Gain (Loss) Results summary and transfer the amount to your Asset Entry Worksheet and to Form 4797: Sales of Business Property.
In addition to depreciable asset sales, TurboTax Business allows you to enter information regarding the:
- Theft or destruction of assets
- Installment sale of assets
- Exchange of assets for other assets that are like-kind in nature
- Section 179 carry-overs (unused portion of your section 179 deduction from a previous tax year that can be applied to the current tax year).
The IRS allows three methods for calculating asset depreciation: Modified Accelerated Cost Recovery System (MACRS), straight line, and Section 179.
Most property must be depreciated using the MACRS method, in accordance with IRS rules. For this reason, TurboTax Business uses MACRS by default. Here we provide a brief overview of the three methods; should you require more detail, refer to page 8 of IRS Publication 946: How to Depreciate Property.
This method allows for a larger depreciation deduction when an asset is new, with the deduction decreasing and then leveling out until the entire cost of the asset has been deducted. The MACRS calculation is based on the asset's anticipated useful life and convention. Convention determines depreciation amounts for assets regardless of the actual acquisition or disposal date.
The IRS prohibits the MACRS method in certain cases:
- Assets you began using in your business before 1987
- Certain assets owned or used in 1986
- Intangible property
- Films, videotapes, and recordings
- Certain corporate or partnership property acquired in a non-taxable transfer
- Property you elected to exclude from MACRS
The straight line depreciation method allows you to deduct the same amount of depreciation during every year of an asset's useful life.
The straight line depreciation amount is the cost of asset minus the salvage value, divided by the number of useful life years. For example, an asset that cost $10,000 originally and will be worth $1,000 after a useful life of 15 years will have a straight line depreciation of $600 per year. [(10,000 - 1,000) / 15] = 600
Assuming you're allowed to use it, straight line depreciation can be beneficial if your business is new and you expect limited income in the early years because it gives you a larger deduction than MACRS towards the end of the asset's useful life. If you choose straight line depreciation for an asset, you must continue to use straight line depreciation for the life of the asset; you cannot later switch to MACRS.
Straight line depreciation is submitted on Form 4562: Depreciation and Amortization, Sections B and C.
Instead of depreciating an asset over its lifespan, you might be able to deduct the entire expense during the asset's first year of use. See Section 179, below.
TurboTax Business applies the MACRS depreciation method by default. However, you have the option to apply the straight line depreciation method to a business asset.
Caution: Switching to straight line depreciation requires a comprehensive knowledge of depreciation methods, asset classes, and recovery periods. For this reason, we advise against doing so unless you are absolutely sure that you know what you're doing.
- The depreciation method you choose must be applied to all assets in the same asset class.
- If you choose straight line depreciation for an asset, you must continue to use straight line depreciation for the life of the asset. You cannot change to MACRS in the future.
To apply straight-line depreciation to an asset:
- In TurboTax Business, select the Federal Taxes tab, and then the Deductions button.
- Select Assets (depreciation) – Start. If you have already submitted an asset, select Edit.
- On the Business Assets Summary screen, select Add Another Asset to begin entering assets.
- Select the asset and then select Edit.
- In the Type of Asset window, select Other. On the next screen, select Other asset type.
- Follow the on-screen instructions until you reach the Enter Asset Type and Class screen.
- Select Non-recovery Property from the Depreciation Type drop-down menu, and No Entry from the Asset Class drop-down menu.
- Enter the Recovery and AMT Recovery Periods in years.
- Select Continue to advance to the Choose a Depreciation Method screen.
- Select a depreciation method from the list and select Continue.
- Review the Asset Entry Worksheet shown at the bottom of the page. (If it's not visible, select the Show Tax Form link.)
- Verify that your asset entry is correct and continue with your return.
Instead of depreciating an asset over a number of years, you might be able to deduct the entire expense in the asset's first year of use. This is referred to as a first-year expense or Section 179 deduction.
When you indicate that your asset was placed in service during the current tax year, TurboTax Business gives you the option of claiming a Section 179 deduction if the asset qualifies. If you choose to go that route:
- Your asset is no longer depreciated over a period of years;
- Your asset's original cost (basis) is reduced by the amount of the deduction ;
- You cannot later revoke the Section 179 election through an amended return.
To qualify for Section 179 deduction, the asset must be:
- Purchased, not leased, for use in your trade or business;
- Used more than 50% in your trade or business;
- Placed in service (purchased, acquired, or converted to business use) during the current tax year; and
- Acquired from a non-related party.
You cannot claim a Section 179 deduction for:
- Real property (e.g., land, building, sidewalks, landscaping, parking lots);
- Income-producing real property;
- Investment property;
- Assets used 50% or less by your business;
- Assets acquired in a tax-free exchange or from a person or entity with whom you share a close relationship as specified by the IRS; or
- Intangible assets such as copyrights or patents.
Section 179 deductions are subject to these limitations:
- You cannot claim a Section 179 deduction for more than $500,000 of the cost of qualified assets placed in service during the year. (The limit for qualified enterprise zone property and qualified renewal community property is $535,000.)
- Your Section 179 deductions cannot be more than your net business income. Section 179 deduction amounts that exceed your net business income can be carried over and used in a subsequent year.
- The deduction amount is reduced if the total cost of all Section 179 assets you placed in service this year is more than $2,000,000. (The $500,000 deduction limit, referenced above is reduced by one dollar for every dollar of total acquisitions in excess of $2,000,000.)
That's a lot of information, but TurboTax Business will check for these limitations as you answer the interview questions.
Advantages and disadvantages of Section 179 deductions
- Taking a Section 179 deduction lets you decrease your net business income by increasing your deductions in the tax year you acquire an asset. If your business is operating at a profit, it's to your advantage to claim the Section 179 deduction.
- A Section 179 deduction can reduce your cash outflow by decreasing your tax liability.
- Your total Section 179 deduction is limited to $500,000 ($535,000 for qualified enterprise zone property and qualified renewal community property), so if your new asset expenses for the year exceed this amount, it's to your advantage to take the regular depreciation deduction on some assets.
Section 179 recapture
You must report the recapture amount of a prior-year Section 179 deduction as income if any of the following occurred before the asset's recovery period (or useful lifespan as defined by the IRS) was up:
- You stopped using the asset in your business
- Business use of the asset fell below 50%
- You sold or otherwise disposed of the asset
- The asset was stolen or subject to a casualty
The amount you report as income is the portion of the deduction that would have remained had you used standard depreciation instead of Section 179. This is known as Section 179 recapture.
For more information, refer to IRS Publication 946, How to Depreciate Property.
TurboTax Business easily calculates Section 179 deductions on assets acquired in the current tax year.
To enter a Section 179 asset:
- Select the Federal Taxes tab, and then click Deductions right below it.
- Click the Start or Edit button to the right of Assets.
- Follow the on-screen instructions. When you get to the How Do You Want to Deduct this Item? screen, select Deduct all or part of the item's value this year.
- Enter the amount of Section 179 deduction you want to claim for the asset. Do not exceed the cost of the asset.
To enter a Section 179 recapture:
- Select the Federal Taxes tab, and then click Income right below it.
- In the Dispose of Business Property section, click the Start or Edit button to the right of Business property/assets.
If the next screen is Select Disposed Asset, click Done, and then Yes.
- Answer the question regarding like-kind exchange and casualties.
- Enter asset disposal information including the date of disposal, the amount received for the asset, and any expenses incurred in the disposal of the asset.
TurboTax Business calculates the Section 179 recapture amount and records it on your Asset Entry Worksheet.