Depreciation
The deduction of the cost of a tangible business asset over its useful life, reflecting wear, tear, or obsolescence.
Detailed Explanation
For tax purposes, depreciation is governed by the Modified Accelerated Cost Recovery System (MACRS) under IRC Section 168. Common methods include 200% declining balance and straight-line. Section 179 expensing and Section 168(k) bonus depreciation allow accelerated deductions: bonus depreciation under OBBBA was permanently restored to 100% for qualifying assets placed in service after January 19, 2025. Real property is depreciated over 27.5 years (residential rental) or 39 years (commercial). Depreciation reduces basis, affecting gain or loss when the asset is later sold.
Key Points
- Governed by MACRS under IRC §168; recovery periods are set by asset class.
- Residential rental real property: 27.5 years. Nonresidential (commercial) real property: 39 years. Both use straight-line.
- Section 179 and Section 168(k) bonus depreciation can accelerate or fully expense qualifying property in year one.
- Depreciation reduces adjusted basis, increasing gain (and recapture) on a later sale.
- Depreciation is "allowed or allowable": even if you skip it, basis is still reduced and recapture still applies.
Practical Example
A business buys $35,000 of office furniture and equipment (7-year MACRS property) and a $400,000 commercial building (excluding land). The equipment can be fully expensed in year one via Section 179 or bonus depreciation, while the building is depreciated straight-line over 39 years, about $10,256 per year. Reclassifying part of the building via a cost segregation study could move some components into shorter 5, 7, or 15-year classes.
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