What Is Depreciation? How It Works and Why It Matters
Written by
Daria Uhlig
Edited by
Joe Evans
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Depreciation is how businesses spread the cost of expensive, long-lasting items over time instead of writing them off all at once. In plain terms, it recognizes that assets like vehicles, equipment and buildings wear out gradually and shouldn’t hit your finances in a single year.
For taxes, depreciation can lower taxable income over several years. For accounting, it creates a more accurate picture of how profitable a business really is.
Understanding how depreciation works helps business owners, investors and self-employed professionals make smarter financial and tax decisions.
At A Glance
Item Details Concept Depreciation What It Does Spreads the cost of assets over multiple years Who Uses It Businesses, landlords, self-employed individuals Tax Benefit Lowers taxable income over time Common Assets Vehicles, equipment, buildings, furniture Main Risk Incorrect asset life or depreciation recapture
What Is Depreciation?
Depreciation reflects the reality that most physical assets lose value as they’re used. Equipment wears down, vehicles rack up miles, and furniture eventually needs replacing. The IRS allows businesses to deduct part of an asset’s cost each year to account for this decline in value.
Instead of deducting a large purchase all at once, depreciation spreads the deduction over the asset’s useful life, which the IRS defines and categorizes by asset type (IRS Pub. 946).
Why Depreciation Matters
Two key factors make depreciation important for this coming tax season:
Depreciation for Taxes
For tax purposes, depreciation reduces taxable income over multiple years. For example, if a business buys $70,000 of equipment, it may deduct a portion each year rather than the full amount upfront, depending on the method used (IRS Pub. 946).
The IRS assigns assets to recovery periods, called class lives, which determine how long depreciation lasts.
Depreciation for Business Accounting
Depreciation also matters for accounting because it helps match expenses to the revenue they generate. Recording the full cost of an asset in one year can distort profits, especially when revenue fluctuates.
Accounting depreciation smooths expenses over time, producing more accurate financial statements and better year-to-year comparisons.
What Assets Can Be Depreciated?
| Asset Type | Depreciable? | Notes |
|---|---|---|
| Machinery & Equipment | Yes | Must be used for income |
| Vehicles | Yes | Business use required |
| Office Furniture | Yes | Useful life over one year |
| Buildings | Yes | Structure only, not land |
To qualify, the IRS requires that you:
- Own the asset
- Use it for income-producing activity
- Expect it to last more than one year
Assets That Can’t Be Depreciated
| Asset | Why It Doesn’t Qualify |
|---|---|
| Land | No limited useful life |
| Inventory | Consumed within one year |
| Personal-use property | Not income-producing |
| Fully depreciated assets | Cost already recovered |
The IRS is explicit that land and personal-use assets aren’t depreciable.
How Depreciation Works
“Useful life” refers to how long an asset is expected to generate income. The IRS assigns standard recovery periods using the Modified Accelerated Cost Recovery System (MACRS).
| Asset Category | Recovery Period |
|---|---|
| Vehicles, computers, machinery | 5 years |
| Office furniture | 7 years |
| Residential rental property | 27.5 years |
| Commercial real estate | 39 years |
Salvage value is what an asset may be worth at the end of its useful life, though many tax depreciation methods assume zero salvage value.
Annual Depreciation Explained
Rather than deducting the full purchase price in year one, depreciation allows a portion of the cost to be deducted annually. This contrasts with Section 179, which allows certain assets to be expensed immediately, subject to limits.
Common Depreciation Methods
| Method | Best For | How It Works |
|---|---|---|
| Straight-Line | Predictable assets | Same deduction each year |
| Declining Balance | Fast-aging assets | Larger early deductions |
| Sum-of-Years Digits | Vehicles, machinery | Front-loaded deductions |
| Units of Production | Usage-based assets | Based on output |
Straight-Line Depreciation
Straight-line depreciation spreads the cost evenly over the asset’s useful life.
Formula:(Cost ??’ Salvage Value) ÷ Useful Life
Example:A $300,000 rental building (excluding land), depreciated over 27.5 years, equals about $10,909 per year.
Accelerated Depreciation
Accelerated methods allow larger deductions earlier in an asset’s life.
- Declining Balance: Front-loads depreciation, often at double the straight-line rate
- Sum-of-the-Years’ Digits: Uses a fraction to accelerate early deductions
- Units of Production: Depreciation based on actual usage
These methods are commonly used for equipment and technology that loses value quickly.
Depreciation vs. Expense Deductions
| Depreciation | Expense Deduction |
|---|---|
| Spread over years | Deducted in one year |
| Required for many assets | Allowed for short-term items |
| Long-term tax planning | Immediate tax benefit |
Section 179 allows certain assets to be expensed immediately, but it replaces depreciation rather than working alongside it.
Depreciation For Rental Property And Investments
Rental property depreciation applies to the structure only, not land (IRS Pub. 527).
| Property Type | Recovery Period |
|---|---|
| Residential rental | 27.5 years |
| Commercial | 39 years |
Example:A $500,000 rental property with $50,000 allocated to land allows depreciation on $450,000. That equals about $16,364 per year using straight-line depreciation (IRS Pub. 527).
Important: When the property is sold, depreciation is subject to depreciation recapture, which is taxed separately from capital gains (IRS Pub. 544).
Depreciation Recapture
When you sell, the IRS recaptures depreciation at a separate tax rate. This doesn’t eliminate the benefit, but it’s an important planning consideration.
Common Depreciation Mistakes To Avoid
| Mistake | Why It Matters |
|---|---|
| Depreciating land | IRS disallows it |
| Wrong recovery period | Can trigger corrections |
| Ignoring recapture | Leads to tax surprises |
| Poor records | Increases audit risk |
Final Take to GO
Depreciation is a powerful tool that helps businesses and investors manage large purchases, reduce taxable income and report profits accurately. When used correctly, it can improve cash flow and long-term planning — but mistakes can be costly.
Understanding depreciation rules, choosing the right method and keeping accurate records are essential to maximizing benefits while staying compliant.
Allison Hache contributed to the reporting for this article.
Data is accurate as of Feb. 2, 2026, and is subject to change.
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