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A Basic Guide to Depreciation for Small Businesses

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As a small business owner, you can deduct depreciation that your assets experience over time. Here’s what to know about depreciation and how to calculate it.

Key takeaways:

  • Depreciation is the loss of value an asset experiences over time
  • Small businesses can deduct depreciation from assets like cars, property, and equipment
  • There are three methods to calculate depreciation: straight-line, accelerated, and Section 179, all with pros and cons
  • Discuss your options with a tax expert at Provident CPA and Business Advisors

You have many concerns when you’re doing your taxes as a small business owner. You have to gather your expenses and records, report income properly, and ensure that you’re taking all the right credits and deductions. This is all on top of paying quarterly estimated taxes and managing your finances. 

Tracking depreciation is one way to significantly reduce a tax burden each year. It may sound like a confusing concept initially, but once you understand the essentials, it’s pretty straightforward. 

Here is a basic guide to depreciation as a small business owner:

What is depreciation?

When you purchase an asset, the value of that asset decreases over time. The amount of value lost is known as depreciation. 

This is important for business owners because you can write off depreciation on your annual tax return as a deduction, lowering taxable income and thus the amount you’re taxed. Even though an asset depreciates, it is not necessarily a negative, since it helps you save on taxes.

One of the most common uses of the term depreciation occurs in the auto world. When you purchase a new car, it loses value as soon as you drive it off the lot, aka depreciates. It is immediately considered a used car.

Depreciating assets that you may use in your business include expensive equipment or machinery, real estate, technology like computers, automobiles, and more. Some intangible assets can depreciate as well, including intellectual property. And in that case, the process is known as amortization.

Understanding and calculating depreciation

The next component to understand is how to actually calculate depreciation, which can be tricky when recording your deductions. 

First, a few rules:

  • Your asset must have been in use for more than one year.
  • You need to write off depreciation for the asset’s useful life.
  • Depreciation starts once it is being used and stops when the cost has been recovered or you stop using it for your business.
  • You must be the owner of the property or asset.

You also need to know how long you can write off the depreciation:

  • Assets like office equipment, electronics, automobiles, and appliances have up to five years to be deducted.
  • Furniture and fixtures have seven years.
  • Rental properties have 27.5 years for residential and 39 years for commercial or non-residential.

Next is how to get started with calculations. You have three methods for writing off the depreciation: straight-line, accelerated, and Section 179 methods.

  1. Straight-line method: In this technique, you deduct the same amount of depreciation each year on a given asset over its useful life. To find this amount, subtract the amount you could sell it for at the end of its useful life (the salvage value) from the asset’s cost, and then divide that number by the number of years it will be in use.
  2. Accelerated method: This one allows you to take bigger deductions early on and smaller deductions later. Many small business owners decide to use this method, and it takes less math on your part. You will use the percentages in IRS Publication 946, Appendix A, and the Modified Accelerated Cost Recovery System (MACRS) created by the IRS. This approach is beneficial for businesses in need of cash because it allows them to deduct more during the first few years after buying an asset.
  3. Section 179 Deductions: Section 179 deductions allow you to deduct the full cost of an asset the year you acquire it for business. The maximum deduction is $1,050,000, and the value of property purchased limit is $2,620,000 for 2021. This option provides a more immediate, huge tax break. The government started offering this option after the Tax Cuts and Jobs Act was passed in December 2017, as an incentive for small business owners to make purchases to grow their businesses. This deduction can be used for computers, business machinery, cars, and office equipment.

Various software options can help calculate depreciation and save asset information from year to year. But it’s always wise to talk to a tax professional about your options so you can land on the right method. Otherwise, you could be leaving money on the table that your small business needs now.

Working with a small business financial expert

Depreciation of business assets is not always easy to understand. But you always must be thorough when completing your tax return and deducting expenses. You never want to do something suspect that will attract the attention of the IRS.

Talk to a tax professional who will help you understand tax laws and best practices you should follow. Always make sure you’re taking advantage of all tax breaks available—and remember that sometimes these change from year to year.

The team at Provident CPA and Business Advisors is here to help. We assist in putting the right financial plans in place to grow small businesses and help them pay the least amount of tax legally possible. We make sure you don’t miss anything when preparing your taxes, including credits and deductions.

Contact us today to get started with an experienced tax professional.

Drive Down Your Taxes with These Vehicle Deductions

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Car and truck expenses can be confusing on your tax return. What are considered eligible expenses? And what are the current limits and mileage rates?

Key takeaways:

  • An individual who owns a business or is self-employed can deduct vehicle expenses 
  • Automobile costs based on mileage or actual expenses are eligible
  • Mileage rates have changed between 2020 and 2021
  • Depreciation limits vary based on when the vehicle was purchased and put in service
  • Certain vehicles used at least 50% for business qualify for the Section 179 deduction

When you run your own business, ensuring you are claiming all applicable credits and deductions will lower your tax burden. And you can deduct qualifying business vehicle expenses, like gas and repair costs, when you use a car for your business. But there are specific eligibility requirements for these deductions, and not all employees who use their vehicle for work will be able to claim them.

So, what are the eligible car and truck expenses? What does the process look like for claiming them? Here’s an overview of how to leverage vehicle expenses to drive down your taxes:

Who can deduct vehicle expenses?

To be eligible for vehicle expense deductions, an individual must own a business or be self-employed. This means that a regular W-2 employee cannot deduct car expenses on their tax return, even if they use it to travel to and from work every day. Some employers may reimburse costs if workers are required to use their vehicles for work, but employers are not required to do so.

If you are eligible, but you use the vehicle both for personal and business purposes, you need to split your expenses when doing your taxes. The deduction will be based on the percentage of mileage that you use solely for your business. 

Next, let’s cover which expenses you can deduct.

What car and truck expenses are eligible?

It’s first important to note that there are two methods to calculate vehicle expenses:

  1. Standard mileage rate: If you choose this option, you must use this method in the first year you use the car and your business. And if you lease a vehicle, you must use it for the entire lease period.
  2. Actual expenses: Using this method requires you to figure out actual car expenses. The IRS includes the following as applicable expenses:
  • Depreciation (limits discussed in a later section)
  • Lease payments
  • Gas and oil
  • Tires
  • Repairs and tune-ups
  • Insurance
  • Registration fees

Now, let’s look at the current mileage rates for both 2020 and 2021 taxes, along with depreciation limits.

Mileage rates for 2020 and 2021

For 2020 tax returns, due in April 2021, the mileage rate is 57.5 cents per mile, and for 2021 tax returns, the rate is 56 cents per mile. If you decide to use the standard mileage rate option described above, these are the numbers you need to know when filing your taxes. 

Depreciation limits

If you outline your actual car expenses, you need to know the depreciation limits for cars and trucks used for business. 

For vehicles that are eligible for the bonus first-year bonus depreciation deduction that were purchased after September 27, 2017, and used for business during 2020, the depreciation limit is $18,100 for the first tax year, $16,100 for the second, $9,700 for the third, and $5,760 for each year thereafter.

If a vehicle was acquired before September 28, 2017, and placed in service after 2019, bonus depreciation is not allowed.

For vehicles first used in the business in 2020 but do not qualify for the first-year depreciation deduction, the limit is $10,100 for the first year, $16,100 for the second, $9,700 for the third, and $5,760 for each year thereafter.

The Section 179 deduction

Section 179 of the tax code provides guidelines for businesses to deduct certain necessary equipment. Qualifying work vehicles are generally only used for business purposes and include:

  • Vans or vehicles that seat nine or more passengers behind the driver’s seat
  • Classic cargo vans (vehicles that have an enclosed driver’s compartment or cargo area, have no seating behind the driver’s seat, and have no more than 30 inches of body in front of the windshield)
  • Heavy construction equipment
  • Some tractor trailers

For typical passenger vehicles that are used more than half of the time in qualified business use, the Section 179 deduction plus bonus depreciation has a limit of $11,160 for cars and $11,560 for trucks and vans.

Excluded from the limits are ambulances, hearses, taxis, transport vans, non-personal vehicles, heavy non-SUV vehicles, and trucks with at least six feet of interior cargo area, and others.

Some heavier vehicles, with a gross weight rating over 6,000 pounds but no more than 14,000 pounds, may qualify for $25,000 in deductions if the vehicle is acquired and placed in service before December 31.

Other Section 179 vehicle deduction notes:

  • The vehicle’s title must be in the company name, not the company owner’s name.
  • The vehicle must be financed with leases and loans that qualify.
  • Depreciation limits are reduced by the percent of personal use if the vehicle is used for business less than 100% of the time, but it must be used for business at least 50% of the time.
  • The Section 179 deduction can only be claimed in the tax year that the vehicle is placed in service.

These tax laws can get complicated fast. It’s always wise to work with a tax professional to get the help you need when preparing your tax returns and claiming expenses related to work vehicles.

Getting tax help for your business

When you’re unsure how to prepare your tax return or whether you qualify for business vehicle expense deductions, work with the team at Provident CPA & Business Advisors. We’ll make sure you’re claiming all credits and deductions for which you qualify. We also offer advice and guidance on other tax-minimization strategies and business planning for the future. 

Contact Provident to get started with one of our tax professionals.