What Is Depreciation for Tax Purposes?
In plain English
For tax purposes, depreciation is a deduction that allows business owners and real estate investors to recover the cost of tangible assets — such as equipment, vehicles, and rental properties — over their useful life as defined by the IRS. Rather than deducting the full cost in the year of purchase, depreciation spreads the expense over multiple years, reducing taxable income annually.
How Does the IRS Determine Depreciation Schedules?
The IRS assigns assets to property classes with specific recovery periods. Residential rental property depreciates over 27.5 years; commercial real estate over 39 years. Computers and office equipment typically depreciate over 5 years; vehicles over 5 years; office furniture and fixtures over 7 years. The Modified Accelerated Cost Recovery System (MACRS) governs most depreciation calculations for U.S. businesses.
What Is Bonus Depreciation and Section 179?
Section 179 allows immediate deduction of the full cost of qualifying equipment and software up to an annual limit, currently over $1 million. Bonus depreciation allows a large percentage of qualifying new or used property costs to be deducted in the first year without a dollar cap. Both provisions accelerate deductions, improving cash flow in the year of purchase.
What Happens When You Sell a Depreciated Asset?
When you sell a depreciated asset at a gain, the IRS 'recaptures' prior depreciation deductions and taxes them — for real estate, at a maximum rate of 25%. This depreciation recapture is taxed as ordinary income up to the amount of depreciation previously claimed, even if the overall sale qualifies for capital gains treatment. Planning for recapture is essential in real estate exit strategies.
Frequently asked questions
Can individuals claim depreciation, or only businesses?
Individuals who own rental property or use property for business purposes can claim depreciation. A person who rents out a home or owns investment real estate deducts depreciation on Schedule E. Personal-use property — your primary residence, personal vehicle — cannot be depreciated.
What is the difference between depreciation and amortization?
Depreciation applies to tangible assets like buildings and equipment. Amortization applies to intangible assets like patents, trademarks, and goodwill. Both spread the cost of an asset over its useful life, but the IRS applies different rules and recovery periods to each category.
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Related terms
Tax Deduction
A tax deduction reduces your taxable income, lowering the amount of income subject to tax. The actual tax savings depend on your marginal tax bracket.
Capital Gains Tax
Capital gains tax applies to profits from selling assets like stocks, real estate, or collectibles. The rate depends on how long you held the asset and your total income.
Self-Employment Tax
Self-employment tax covers Social Security and Medicare contributions for self-employed individuals who do not have an employer withholding these taxes. The current combined rate is 15.3%.
Tax Shelter
A tax shelter is any legal strategy that reduces taxable income, often through investments or business structures that generate deductions or credits. Abusive shelters that exist solely to evade taxes are illegal.
Property Tax
Property tax is an annual tax levied by local governments on the assessed value of real estate and, in some jurisdictions, personal property like vehicles. It is a primary funding source for schools and public services.