Small Business Tips: Why Use Depreciation To Reduce Tax Bill?

Small Business Tips: Why Use Depreciation to Reduce Tax Bill?

Every asset within your business will definitely lose its value in the long run. When your assets lose their value, the value of your business’ assets will be lessened. This should be regarded for your small business accounts as well which is known as depreciation. It may sound counterintuitive, but small business owners can obtain a real appreciation for depreciation, even if it seems complicated. 

So, how can you use depreciation? How does it affect your small business and how can you make a claim for it? 

What is Depreciation? 

Normally, when you think about depreciation, it’s in the manifestation of a quantified reduction or decrease in an asset’s value over its useful life. For example, when we buy a new car and test it out at the dealership’s parking lot, it immediately becomes a “used car,” and its value has also “depreciated”. With that example, depreciation may appear as if it’s a negative thing. However, this is not always the case, particularly when it comes to business expenses. 

For small business finances, depreciation is actually a positive thing, it allows business owners for beneficial small business tax write-offs. In this matter, depreciation can give the chance for business owners to decrease their taxes by reducing a portion of the cost or even the total cost depending on the kind of assets like capital goods, equipment, and even real estate. 

List of Assets That Can Be Depreciated 

Here are the assets that can be depreciated by savvy small business owners while calculating their income tax: 

  • Real Estate Property: If you own a property and you use it as a rental property to generate income. 
  • Equipment: For instance, in a restaurant, assets can be walk-in freezers, cooking appliances, dishwashers, tables, chairs, cookware, and etc. 
  • Machinery: Hand tools, drill presses, generators, power tools, air compressors, construction equipment, and many more.  
  • Intangibles: This covers the value of computer software, patented ideas, as well as copyrighted materials you’ve developed or created. 
  • Buildings: If the building is utilized to generate income, you can depreciate it even if the value of the land on where the structure sits is not included in the depreciation calculation. 
  • Vehicles: Trucks, vans, cars, boats, aircraft, and other kinds of transportation equipment can be claimed for depreciation as long as you’re using it for business purposes. 

Two Main Methods in Calculating Depreciation 

  •  Straight Line Depreciation

This method is where you calculate the depreciation of an item based on the actual cost price of the item. Every year, you can claim the same amount. 

  • Declining Balance Depreciation

This second method allows you to compute the depreciation cost on the diminishing value of the car, so the amount you claim each year will differ as the value of item decreases. 

You’re required to use the same method for all of your assets. However, you need to use the same method on an asset during the financial year. Verify this with your accountant to determine the best method for you. 

What’s Depreciable and What’s Not? 

You won’t be able to claim tax depreciation for all of your business assets. The ones that can only be depreciated are those you are using for your business and have value and determinable life expectancy influence whether they qualify but you can’t claim tax for assets such as land or buildings, stock, intangible assets like goodwill so ask this first with your accountant. 

Importance of Record Keeping 

It’s crucial that you keep all of your financial records up to date for several reasons, one of them is having the chance to claim tax for depreciation. A lot of businesses leave this matter to the hands of their accountants but it would be essential to understand what needs to appear in the schedules. Here are the following things that need to show: 

  • Fixed assets like proof of purchase 
  • The claim depreciation
  • The modified tax value per asset 
  • An agreeable invoice

The Importance of Calculating Depreciation and How to Do it Properly 

Since you’ve understood what depreciation can do for your small business’s bottom line, you may be curious about how you can figure it out on your own balance sheet or on the calculations of your income tax. 

For you to calculate effectively, you must use a great accounting software program or tax preparation tool, or probably hire a CPA firm that can help you simplify the process or tax depreciation together with grabbing complete advantage of its benefits. 

There are different mechanisms and formulas for depreciation calculation but it might be best to stick to the basics.