Which Assets Can Be Depreciated?
In general, property that you own can be depreciated if it meets all of the following requirements:
- It is used in a trade or business (which will be the focus of our discussion here) or held for the production of income as an investment property.
- It has a finite period of usefulness in your business that can be estimated with some confidence, and that is longer than one year.
- It wears out, decays, gets used up, becomes obsolete, or loses value from natural causes.
Examples of depreciable assets are cars, computers, office furniture, machines, buildings, and significant additions or improvements (as opposed to repairs) to these kinds of property.
Which assets are not depreciable? Land is probably the most commonly encountered property that is not depreciable. As a rule you can only "recover" the cost of land when you eventually sell it, at which point you'll subtract the cost from the sales price to determine your taxable gain. So, when you purchase a business building and the land on which the building is situated, the cost of the land must be subtracted from the total cost of the property before you can determine the depreciation expense for the building.
The costs of clearing, grading, planting, landscaping, or demolishing buildings on land are not depreciable, but are added to the tax basis of the land, so they can reduce your taxable gains on the property when it comes time to sell.
Depreciation is not allowed on personal assets, such as a residence used by you and your family, or an automobile used for pleasure purposes only. If an asset is used partly for personal purposes and partly for business, only the portion of the asset used for business purposes is depreciable.
Other items that are not depreciable are inventory and property you lease or rent from others. However, if you pay for some permanent improvements on property that you lease (for example, you remodel your leased office or store), you can depreciate the cost of the improvements.
Amortizable assets. Some business assets are not depreciable, but the costs can be recovered through amortization; that is, they can be deducted in a series of equal amounts over time for a specified period. An example of this is the cost of starting your business, which can be deducted over a period of 60 months after the business begins to operate.
Intangible assets purchased after August 10, 1993, including agreements not to compete, franchise rights, business licenses, and patents, copyrights, trademarks, trade names, business goodwill, and going concern value that are acquired as part of the acquisition of a substantial portion of a business, must be amortized over the course of 15 years. Most intangible assets acquired before that date cannot be amortized at all; others, such as patents and copyrights, agreements not to compete, designs and patterns, franchises, and customer or subscriber lists, must be depreciated using the straight-line method over their useful life.
Off-the-shelf computer software purchased after August 10, 1993, must generally be amortized over 36 months from the date of purchase. As a result of tax law changes in 2003 and 2004, however, taxpayers may elect to expense in the first year the entire cost of off-the-shelf software purchased and placed in service in 2003 through 2009 (up to $100,000 per year as indexed for inflation). Customized software, on the other hand, must still be amortized over a 15-year period.
As a general rule, any intangible assets created by your business (rather than purchased from someone else) cannot be depreciated or amortized.
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