What is depreciation?

On your business taxes, depreciation (also called capitalization, cost recovery, or amortization) lets you deduct the "used up" part of an asset's cost every year, until the asset no longer retains any value or has been sold, destroyed, or otherwise gotten rid of. Depreciation is based on the idea that business assets eventually wear out, get used up, or become obsolete.

With one notable exception (Section 179), depreciation is required for most "big ticket" business assets that have a useful life of more than one year and wear out over time, such as buildings, vehicles, equipment, office furniture, computers, and tools used by the business. Business assets must meet 3 conditions to be depreciable:

1. The asset must be used to produce business income, rent, or royalty payments.
   • There are exceptions for assets that failed to produce income, although that was their primary purpose.
2. The asset must wear out, decay, become obsolete, or lose value over time.
3. The asset has a useful life that can be measured and lasts over 1 year.

You can't depreciate consumable items like office supplies, even if they last more than a year. You also can't depreciate land, inventory, or leased property.

Once a depreciable asset is sold, bartered, discarded, or destroyed, the transaction is reported on your tax return. The reportable amount is determined by the asset's original basis, accumulated depreciation, as well as any value you got in exchange for the asset and any expenses involved in selling or disposing of the asset.

On your federal taxes, depreciation gets reported on IRS Form 4562, which we'll fill out for you if your return needs it.