Depreciation Basics

Holton Agriculture Education Department

Agribusiness Management Class

Jason M. Larison, Instructor

Depreciation

• Definition– The allowance for wear and tear on equipment and

machinery– Amount of decreasing value in a capital asset allowed

to be deducted from a business tax return– Cost Recovery

• Rules – The rules for farm business depreciation are located in

the Farmer’s Tax Guide (Publication 225) from the IRS

What can be depreciated?

• You can depreciate property only if it meets the following requirements:– It is used in business or held for the production of

income.– It must be expected to last for more than one year. In

other words, it must have a useful life that extends substantially beyond the year it was placed in service.

– It is property that wears out, decays, gets used up, becomes obsolete, or looses value from natural causes.

• Depreciable property can be either tangible or intangible

Tangible Depreciable Property

• Purchased property you can see or touch– Livestock (purchased)– Machinery– Buildings and improvements, fences– Dams, ponds, or terraces– Irrigation systems and water wells– Partial business use

• You can claim depreciation on the part of a vehicle used in the business (ex - 1/2 business value of a truck)

Intangible Depreciable Property

• Purchased property that has value that you cannot readily see or touch– Computer Software– Copyrights, patents, etc

What cannot be depreciated?

• Property placed into service and disposed of in the same year.

• Land (land can never be depreciated)• Inventory

– You cannot depreciate property held for resale in the normal course of business

• Leased property– The value of the lease is already showing up as a rental

expense

• Raised Market Livestock (Because there is no cost to recover)

Section 179 Deduction

• A total of $24,000 may be taken in a section 179 deduction. – Once taken, the amount can no longer be

depreciated. – You can however, depreciate out the balance if

the asset is over $24,000.– Starting in 2003 the amount will be $25,000

When depreciation begins & ends?

• Begins– When you “place the

property in service”.

– When it is ready and available for a specific use in the business

• Example– When it was bought for the

business

• Ends– When the cost of the item

has been recovered or when it is retired from service, whichever happens first

• Example– When it is sold or is not

longer useable

Depreciation Methods MACRS - Modified Accelerated Cost Recovery

System (Half Year Conventions)• 150% Declining

Balance -– Only Option

• GDS - General Depreciation System

• Straight Line– Either Option

• GDS - General Depreciation System

• ADS - Alternative Depreciation System

– Longer time for depreciation

Depreciation Methods Older (less common ways of depreciation)

• ACRS (Acellerated Cost Recovery System)– Used on Property Placed in

Service before 1987

– Cannot be used on property placed in service after 1987 (you must use MACRS)

• Straight Line – Standard method of

depreciation with a similar amount taken out each year

– Does not have the advantage of a half year convention which means you must wait to start later

Number of Years Allowed for Depreciation

• Consult the Farmer’s Tax Guide (Publication 225) to find out the specific lengths of time for depreciation– Cattle (Breeding) >> 5 yrs GDS, 7 yrs ADS

– Hogs (Breeding) >> 3 yrs GDS, 3 yrs ADS

– Fences >> 7 yrs GDS, 10 yrs ADS

– Single use farm buildings >> 10 yrs GDS, 15 yrs ADS

– Grain Bins >> 7 yrs GDS, 10 yrs ADS

Depreciation Percentages - 5 year(Half Year Convention)

Half of Yearly Depreciation is allowed for year placed in service.

• 150% Declining Balance (DB)

– Year 1 - 15.00%

– Year 2 - 25.50 %

– Year 3 - 17.85 %

– Year 4 - 16.66 %

– Year 5 - 16.66 %

– Year 6 - 6.33 %

• Straight Line - Half Year– Year 1 - 10 %

– Year 2 - 20 %

– Year 3 - 20 %

– Year 4 - 20 %

– Year 5 - 20 %

– Year 6 - 10 %

Advantages of theDeclining Balance Method

• More Depreciation Claimed early in the live of the asset– Year 1 would be 15 % versus 10 %SL– Year 2 would be 25.5 % versus 20 % SL

***Good if you know you will have too much income (problems) immediately in the next couple of years

Advantages of Straight Line

• More depreciation expense is claimed per year later in the life of the asset– Year 5 would be 20 % versus 16.66% MACRS– Year 6 would be 10 % versus 8.33% MACRS

**Good if you do not predict to have income problems (need the depreciation) in the next couple of years, but want to be safe in the future

Advantages of ADS

• Allows for the depreciation to be spread out over a longer number of years.

• Could be an advantage for emergency purchases, i.e. - those not made for a direct impact on income taxes (save it for later when you might need it!)

Summary

• Depreciation allows “cost recovery” on capital asset purchases in the farm business

• Depreciation is a non-cash expense on your schedule F (farm profit or loss statement)

• Record Depreciation on Tax Form 4562

• Section 179 Deduction ($25,000 for 2003) - Allows a 1 time deduction to help on major farm purchases

• Two main methods - MACRS and Straight Line

• Know the rules - they are always changing, stay on top of them so you can maximize your after-tax income.