What Is Depreciation? A Complete Guide
Depreciation is the process of allocating the cost of a tangible asset over its useful life. It represents how much of an asset's value has been used up.
Why Does Depreciation Matter?
For businesses, depreciation is a way to recover the cost of an asset over time. Instead of deducting the entire cost of a purchase in the first year, tax laws often require you to spread the deduction over the asset's "useful life."
For individuals (like car owners), depreciation represents the real money you lose as your asset ages and wears out.
key Terms You Should Know
- Cost Basis: The original value of the asset, including purchase price, taxes, and setup fees.
- Useful Life: How long the asset is expected to be productive (e.g., 5 years for a laptop).
- Salvage Value: The estimated resale value of the asset at the end of its useful life.
Common Methods
There are several ways to calculate depreciation:
- Straight Line: The value decreases by the same amount each year. Simplest and most common.
- Declining Balance: Depreciation is higher in the early years. Good for cars and tech.
- MACRS: The standard tax depreciation system used by the IRS in the United States.