I am starting a business next year and am trying to get some clarification on Depreciation/Appreciation. I understand that you can write off for different things such as fixtures, constructions, etc. My question is...If you have $15,000 in these two lines that you can write off, is that essentially profit that goes back to the business? Or is it just an accounting thing?
I.e. -- I am a $15k App/Dep write off so instead of making $20k in profit, I actually make $35k in profit?
I hope this makes sense. Thanks for any help!
Depreciation is an accounting method of allocating the cost of a tangible asset over its useful life and is used to account for declines in value. Businesses depreciate long-term assets for both tax and accounting purposes.
For tax purposes, depreciation is an expense that will reduce the amount of income you are taxed on. In you question, you used $20,000 profit (or net income) as part of the example, but depreciation is used to determine your profit. The $15,000 would be deducted from the $20,000 so you would have $5,000 in taxable income.
Depreciation also affects your basis in business property. This affects your taxes when you sell/dispose of the asset. For example, if you have equipment you purchased new for $10,000 you normally would depreciate it for ten years so you would have a deduction each year for $1000.
If there was no depreciation and you sold the equipment after five year for $7000, you would have a $3,000 loss. (Basis=purchase price of $10,000) which could be used to reduce other business income.
However, because you claimed $5,000 in depreciation, your adjusted basis is $15,000. $15,000 minus $7000 equals $8000 gain- which is then added as business income.
I hope this either provides a basic explanation or makes you realize how complicated depreciation can be.
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Appreciation is not really taken into account until you sell the asset. Depreciation is when you purchase an asset that has a useful life greater than 1 year, you are required to take the expense of buying the asset over time instead of just in the year you purchased it. Depreciation is a deduction not income. So say you have $20k in profits before depreciation, then you have $5k of depreciation your income would be $15k. Normally when you purchase an asset for $15k you do not get the full deduction in the year you purchased it. You follow tax depreciation methods (MACRS) and take the deduction over time. There are special situations where you can take the full deduction in the first year (179 or bonus depreciation).
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