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Tax Clinic:
Determining depreciation rates
By Comprehensive Accounting Corp. of Aurora , Illinois. Comprehensive provides a book-
keeping , accounting, and tax service to over 14,000 business clients each month through a
nationwide network of more than 140 franchised offices.
QUESTION: How do I determine
depreciation rates?
ANSWER: The basis of certain
tangible and intangible assets may be
recovered by deductions for depre -
ciation, which is a rational and
systematic allocation for the exhaus-
tion , wear and tear, and obsoles-
cence of depreciable property used in
a trade or business , or held for the
production of income . There are
several allowable methods of compu-
ting depreciation , and selection of
the proper method must be made
after careful examination of the
various factors involved.
In addition to selecting the method
of computing depreciation , the useful
life of the property to be depreciated
must be determined. Useful life is the
number of years over which the asset
will be depreciated , and its deter-
mination is based on the intended
use , the age of the asset , and the
acquisition and policy as to repairs,
upkeep , and replacement. Each
taxpayer can determine the useful life
to which the asset will be used by
him. However, the Internal Revenue
Service publishes guidelines for
depreciation purposes, which guide-
lines provide a range in which a
reasonably useful life will be accep't-
able . For example , the range for
office furniture , fixtures , and equip-
ment is eight to twelve years, and the
range for automobiles is two and
one -half to three and one -half years .
Annual depreciation may be
figured by utilizing any method which
is reasonable and which is consistent
with recognized trade practices. The
Internal Revenue Service has stated
that certain common methods of
depreciation are reasonable , includ-
ing the straightline method , declining
balance and the sum of the years'
digits .
Under the straightline method , the
cost or other basis of the property,
less its estimated salvage value, is
deducted in equal amounts each
year over the useful life of the
property .
Under the declining balance
method of depreciation , deduction
for depreciation is accelerated in the
earlier years , as the depreciation de -
termined under the straightline
method is multiplied by a factor of
one and one -quarter to two times the
rate , as determined under straight-
line .
However , each year this factor is
computed on the undepreciated
basis of the property so that the
accumulated depreciation taken in
past years is subtracted from the
basis of the property ; this results in
larger depreciation in the earlier
years and smaller depreciation in the
latter years . For example, assuming
that an asset was being depreciated
under the double declining method
of depreciation , has a useful life of
five years , and had a cost of
$10 ,000 , the first year's depreciation
would be calculated at the rate of
$4 ,000 ($10 ,000 divided by five
years equals $2 ,000 , times two,
equals $4 ,000) .
The second year , the depreciation
would be $2,400 , as the first year's
depreciation is subtracted from the
basis , resulting in a depreciable
base of $6 ,000 . In the case of real
estate , the declining balance may be
limited to one and one-half times, or
even one and one-quarter times the
LAY
straightline method .
Another accelerated method of
computing deperciation is the sum of
the years' digits method. Under this
method , a fraction is applied to the
basis of the property , less salvage
value, in each year . The denomi-
nator of the fraction is the total of all
the years of its estimated useful life .
Thus, if the useful life is five years ,
the denominator is 15 ( 1 + 2 + 3 + 4
+ 5). The numerator changes from
year to year representing the remain-
ing years of the useful life. The rate
for an asset having a useful life of five
years would be 5 / 15ths in the first
year, 4/ 15ths in the second year ,
and so on .
The method selected for calculat-
ing depreciation can be different for
different assets . However , it must be
selected in the year the asset is
placed in service , and once selected
the method cannot be changed
without permission from the Com-
missioner of the Internal Revenue
Service , except in the case of
changing from
an
accelerated
method of depreciation , such as
declining balance or sum of the years'
digits , to a straightline method .
The use of a particular method of
depreciation must be tailored to the
needs of the particular individual.
The accelerated methods of depre -
ciation produce larger depreciation in
the early years , thus reducing taxable
income during these years. The
straightline method allows a constant
deduction against taxable income
and produces a less dramatic effect in
the early years . Other factors also are
involved in the choice of methods
and should be examined carefully to
determine which of the various
methods will best suit your needs .
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