What expense category is Depreciation Expense?

When a business purchases a significant tangible asset, such as a vehicle, machinery, or office furniture, it's making a long-term investment. Unlike office supplies that are used up quickly, these assets provide value for more than one year. For this reason, the IRS does not allow you to deduct the entire cost of such assets in the year you purchase them.

Instead, you recover the cost over time through an annual tax deduction called depreciation. Depreciation is a non-cash expense that accounts for the wear and tear, deterioration, or obsolescence of an asset. This guide will explain what depreciation is, which assets it applies to, and how it is calculated and reported for tax purposes.

The Depreciation Expense Category

Depreciation is not a direct expense category for a single transaction but a calculated, annual deduction that represents the recovery of a capitalized cost. When you purchase a long-term business asset, you must first capitalize it—meaning you record it as an asset on your balance sheet.

Then, each year, you calculate the depreciation expense for that asset. This annual deduction is calculated on Form 4562, and the total amount is then carried over to your main business tax return (e.g., Line 13 of Schedule C for a sole proprietor).

Important Considerations for Depreciation

The depreciation rules are detailed and specific. Understanding these core concepts is essential for correct tax treatment.

What Property Can Be Depreciated?

According to IRS Publication 946, you can depreciate most types of tangible property if it meets all the following requirements:

• It must be property you own.
• It must be used in your business or to produce income.
• It must have a determinable useful life that extends substantially beyond one year.

You can never depreciate the cost of land.

Depreciation Method: MACRS

For most business property placed in service after 1986, you must use the Modified Accelerated Cost Recovery System (MACRS). This system determines the property's class, recovery period (the number of years over which it is depreciated), and the depreciation method to be used.

Repair vs. Improvement

It is critical to distinguish between a deductible repair and a capital improvement.

• Repair: A cost that keeps property in its normal operating condition is a currently deductible repair expense.
• Improvement: A cost that betters, restores, or adapts property to a new use must be capitalized and depreciated as a separate asset.

The Section 179 Deduction

As an alternative to depreciating an asset over many years, IRS Publication 334 explains that you may be able to elect to deduct the full cost of qualifying property in the year it is placed in service. This is called the Section 179 deduction, and it is subject to annual dollar limits.

Tax Implications and Reporting

The depreciation deduction is a key part of your annual business tax filing.

How to Report the Deduction

The annual depreciation deduction for all your business assets is calculated on Form 4562. This form requires you to provide details for each asset, including its cost, the date it was placed in service, and the depreciation method used. The total depreciation deduction from Form 4562 is then reported on the appropriate line of your business tax return.

What Records to Keep

IRS Publication 946 stresses the importance of keeping detailed records for all depreciable assets. Your records must show:

• When and how you acquired the asset.
• The purchase price.
• The cost of any improvements.
• The date you placed the asset in service.
• The depreciation method and convention used.
• Any Section 179 deduction taken.
• The annual depreciation deduction claimed.
• The date you disposed of the asset and the selling price.

How Fyle Can Automate Tracking for Depreciable Assets

Fyle is the ideal system for the first and most critical step in depreciation: capturing and documenting the purchase of a capital asset.

• Capture Purchase Invoices: Instantly capture the invoice for a new piece of machinery or equipment using the Fyle mobile app or email forwarding.
• Centralize Key Documents: Attach purchase agreements, titles, and warranty documents directly to the expense record in Fyle.
• Categorize for Capitalization: Code the purchase as a Fixed Asset, signaling to your accountant that it must be capitalized and depreciated.
• Automate Your Accounting: Fyle syncs the capitalized cost to the correct fixed asset account in QuickBooks, Xero, NetSuite, or Sage Intacct.