Depreciation spreads a purchase's cost over several tax years, maximizing the deductions you can claim. One depreciation method, the straight-line method, divides the cost evenly. An alternate method, the units-of-production method, divides the cost according to how much you use it. This lets you approximately deduct the actual value the item loses each year from your taxable income. With factory equipment, units-of-production considers literal units of production — the number of units the item produces each year. With other equipment, consider other factors, such as the length of time that the equipment runs.
1. Estimate the item's salvage value, which is its predicted value once you are ready to sell it. For example, suppose that you plan to sell your car after five years, at which time you predict it will fetch $5,000. The car has a salvage value of $5,000.
2. Subtract the item's salvage value from the amount you paid for it. For example, if bought the car for $20,000, subtract $5,000 from $20,000 to get $15,000.
3. Decide a measure for calculating the item's use. With cars, use the number of miles you drive each year. Otherwise, consider units of production or hours of use.
4. Estimate the total use you intend from the item. For example, suppose that you plan to drive a total of 50,000 miles.
5. Divide the item's use during the current year by the total use you intend from it. For example, if you drive 20,000 miles this year, divide 20,000 by 50,000, to get 0.4.
6. Multiply this fraction by the value from Step 2. With this example, multiply 0.4 by $15,000, to get $6,000. This is the depreciation expense you should declare on this year's tax return.
- Accounting: Concepts and Applications; W. Steve Albrecht et. al; 2010
- College Accounting; Douglas J. McQuaig et. al.; 2010
- California State University, Northridge: Depreciation, Amortization, Depletion
- Contemporary Mathematics for Business and Consumers; Robert A. Brechner; 2009
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