Depreciation
Last reviewed 2026-05-11 by Asad Ali, Founder & CEO
The gradual reduction in the value of an asset over time due to wear and tear.
Depreciation allocates the cost of a tangible asset over its useful life rather than recording the full purchase price as an expense in the year of purchase. Common methods include straight-line, declining balance, and units-of-production. It is a non-cash expense that lowers taxable income without money leaving the business. For tax purposes, the IRS requires the Modified Accelerated Cost Recovery System (MACRS), which assigns each asset class a fixed recovery period — typically 5 years for vehicles and computers, 7 years for office furniture, and 27.5 or 39 years for real property. Book depreciation (used in financial statements) and tax depreciation often differ, creating timing differences tracked through deferred tax accounts.
Formula
Straight-Line Depreciation = (Cost − Salvage Value) ÷ Useful LifeExample
A delivery company buys a van for $40,000 with a $5,000 estimated salvage value and a 5-year useful life. Straight-line depreciation = ($40,000 − $5,000) ÷ 5 = $7,000 per year of depreciation expense. After 3 years, accumulated depreciation is $21,000 and the van's book value is $19,000.
Why It Matters for Your Business
Depreciation affects both reported profitability and your tax bill, so understanding it helps you plan equipment purchases and take full advantage of deductions like Section 179.
Practical Tips
- •Consult IRS Publication 946 for the correct useful life classifications of business assets
- •Use Section 179 or bonus depreciation to expense qualifying equipment in year one instead of spreading it out
- •Track depreciation schedules in your accounting software to automate journal entries and avoid year-end scrambling
- •Keep purchase invoices and in-service dates on file — the IRS can disallow depreciation deductions without documentation
Common Questions About Depreciation
How is depreciation calculated?
The formula is: Straight-Line Depreciation = (Cost − Salvage Value) ÷ Useful Life. See the worked example below for a step-by-step calculation using realistic numbers.
What is an example of depreciation?
A delivery company buys a van for $40,000 with a $5,000 estimated salvage value and a 5-year useful life. Straight-line depreciation = ($40,000 − $5,000) ÷ 5 = $7,000 per year of depreciation expense. After 3 years, accumulated depreciation is $21,000 and the van's book value is $19,000.
Why does depreciation matter for my business?
Depreciation affects both reported profitability and your tax bill, so understanding it helps you plan equipment purchases and take full advantage of deductions like Section 179.
How does FiscalInsights help with depreciation?
FiscalInsights tracks depreciation automatically as part of its AI bookkeeping workflow. Connect your bank accounts and the platform handles categorization, reconciliation, and reporting without manual entry.
Related Terms
More Accounting Terms
Accounts Payable
Money owed by a business to its suppliers or creditors for goods or services received but not yet paid for.
Accounts Receivable
Money owed to a business by its customers for goods or services delivered but not yet paid for.
Accrual Accounting
An accounting method that records revenues and expenses when they are incurred, regardless of when cash is exchanged.
Asset
Any resource owned by a business that has economic value and can provide future benefits.
Balance Sheet
A financial statement showing assets, liabilities, and equity at a specific point in time.
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