Tractors and laptops get old, just like their owners. U.S. tax law recognizes that equipment used for a business — farm machinery, computers, trucks and tools — has a limited "useful life." Depreciation lets business owners deduct a percentage of the original cost of an item over its lifetime, rewarding investment and covering some of costs of maintaining older equipment.
Depreciation can be a huge tax advantage for small business owners, if — and that's a big if — you can make sense of the IRS depreciation tables. The depreciation tables spell out exactly how much you can deduct each year for different classes of business property. At first glance, the tables make about as much sense as the box score of a cricket match. But it all becomes clear after you understand some important tax terminology.
For each piece of business property you want to depreciate, you need to answer the following questions in order to use the depreciation tables:
- Which depreciation system applies?
- What is the property class?
- When was the item placed in service?
- What is the basis amount (cost)?
- What is the recovery period?
- Which depreciation convention applies?
- Which depreciation method applies?
The entire depreciation process is ruled by the Modified Accelerated Cost Recovery System (MACRS). MACRS itself is divided into two separate systems of depreciation: the General Depreciation System (GDS) and the Alternative Depreciation System (ADS). In all but a few rare cases — equipment used outside of the country, for example — GDS is the depreciation system that applies.
The IRS has divided every imaginable type of business property — from race horses to tugboats — into nine classes. Each class is named for its useful lifetime. Here are the nine classes and examples of the types of property they cover:
- 3-year property – race horses (doesn't apply to horses placed in service after Dec. 31, 2021), rent-to-own property
- 5-year property – automobiles, computers, cattle
- 7-year property – office furniture, agricultural machinery
- 10-year property – boats, fruit trees
- 15-year property – restaurants, gas stations
- 20-year property – farm buildings, municipal sewers
- 25-year property – water treatment facilities
- Residential rental property – rental apartments or homes
- Nonresidential real property – office buildings or stores
If you want to look up the property class of just about any business property, browse through "Appendix B" of IRS Publication 946: How to Depreciate Property.