A fixed business asset such as furniture, equipment or an office building is considered a capital expenditure. Unlike operating expenses, which receive tax deductions in the year the expenses occur, a firm must depreciate capital expenses over the life of the asset. To properly depreciate capital expenditures, a firm must know the original cost of the asset as well as the length of time the asset will be useful to the business.
1. Determine the original capital expenditure you made to purchase the asset and the asset's salvage value.
2. Subtract the original value of the capital expenditure from the salvage value of the asset to determine the depreciation total. The salvage value is the estimated market value of the asset or the amount the asset can sell for at the end of it's useful life. For example, a business purchases new office furniture for $5,000 and expects the furniture to last for five years. At the end of five years, the business expects the salvage value of the furniture to be $1,500. The depreciation total in this example would be $3,500.
3. Divide the depreciation total by the estimated useful life of the expenditure. In this example, the estimated useful life of the furniture is five years. Depreciate the asset in equal amounts each year. In this example, $3,500 dived by five years is $700 per year.
- Depreciating capital expenditures properly can maximize a firm's cash flow. Estimating depreciation costs and potential savings before a purchase is made can help a business identify which assets are suitable investments. Business accounting professionals often have tax depreciation calculators that estimate depreciation deductions for fixed assets. These calculators enable the business to weigh the tax savings of different assets before making a purchase.
- Sell the asset at the end of its useful life for its salvage value if possible. Report either a gain or loss of the sale of the asset on IRS Form 4797, Sale of Business Property.
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