Preface: “The value of an idea lies in the using of it.” — Thomas Edison
What Is a Depreciation Schedule and Why Does Your Accountant Keep Insisting You Need One?
If you own a business, farm, or rental property, you probably know that you can take a significant business deduction for something called “depreciation.” You likely realize that depreciation is your recovery of the cost of business assets and that it can take a number of years to fully recover such costs. In other words, the tax code lets you deduct the cost of assets placed in service in your business, farm, or rental property, but it doesn’t always let you deduct the entire amount in a single year.
So far, so good. You may have also heard of a “depreciation schedule,” and this may have sounded a bit confusing. Have no fear, it is not really that complicated. A depreciation schedule is simply a list of your business assets that helps to explain what depreciation has already been taken on each asset and how much depreciation remains to be taken on each one.
Each line in a depreciation schedule should include five data points:
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- A description of the asset.
- The date the asset was placed in service.
- The cost basis, including all sales tax, fees, and other transaction costs.
- A useful life. The IRS issues guidelines on lifetimes of depreciable assets. Your accountant should be able to determine for you the useful life of a new asset. If you are hiring a new accountant, the new accountant needs to know what life the old accountant used.
- A method, which is to say, how much is being recovered each year over the useful life of the asset. In some cases, the entire cost may be recovered in the first year under section 179. For real estate and amortized costs, straight-line depreciation must be used, which is to say the same amount is recovered each year over the life of the asset. In most other cases, some form of accelerated depreciation is used. As with the useful life, any accountant should be able to determine this for you for any new asset, but a new accountant needs to know what method the old accountant used.
EXAMPLE: Say you spent $15,000 on an improvement to your rental property in June of this year. This bit of new information becomes a new line your depreciation schedule that says:
Renovation – July 1st, $15,000
Your accountant will know that improvements have a 15-year life and are taken using a straight line method. The amount of remaining depreciation to be recovered will then be decreased in the schedule by $1,000 each year until it reaches zero 15 years from now.
If you have a business, or multiple businesses, with a large number of assets placed in service in different years using different lifetimes and methods, this can get a little involved. But in principle, each line in the schedule is just a record of how deprecation has been taken on a particular asset.
Why Is My Accountant Asking Me for a Depreciation Schedule?
If you are starting a new business, your accountant should create a new depreciation schedule for that business and update it annually. If you are hiring a new accountant to handle an existing business, that accountant should ask you for the depreciation schedule prepared by the previous accountant. Business clients sometimes feel awkward about this kind of request, either because they are not sure what they are being asked for or because they don’t want to have to tell their old accountant they are planning to switch accountants.
There is no reason to feel at a loss. It is entirely normal for businesses to change accountants in the course of their business life. Accountants are entirely used to this. If you paid an accountant in a prior year to prepare your tax returns and you had depreciable property, then the accountant should have prepared a depreciation schedule to be able to correctly figure the depreciation in a way acceptable to the IRS. All documents prepared by the accountant, including the depreciation schedule, are then yours since you paid for them, and you are entirely within your rights to ask for copies.
The schedule tells the new accountant how much depreciation is left to be recovered in future years. You are entitled to recover the entire amount over the life of the asset, but at the same time, you do not want to invite problems by continuing to depreciate after the entire cost has already been recovered. This can be especially tricky if accelerated depreciation, bonus depreciation, or section 179 depreciation have been taken in prior years.
Having a depreciation schedule is also very important in the event that you sell any business assets. This is because the amount of depreciation taken in prior years must sometimes be added back (“recaptured”) when computing your gain on the sale.
Can’t You Just Compute Your Own Depreciation Schedule from Last Year’s Numbers?
In some simple cases, it may be possible to reconstruct a missing depreciation schedule from the previous year or several years’ worth of returns. This will still require asking you, the business owner, many questions about the descriptions of the assets and their purchase dates. The tax forms themselves only contain the annual totals or are broken down only by useful life or type of depreciation (MACRS, section 179, or bonus).
It might help to compare a depreciation schedule to a prison roster. When a group of prisoners is transferred from one prison to another, the new warden needs to be told how long a sentence each prisoner is serving, when he began serving that sentence, and other important information, such as whether the prisoner has had his sentence reduced for good behavior, etc.
Remember the States
Many state laws governing depreciation differ from federal law. So, as you can imagine, depreciation taken on state tax returns may not be the same as depreciation taken on your federal return. So it is a very good idea to keep a state depreciation schedule in addition to a federal one. Even if the numbers are the same in some cases, keeping separate federal and state schedules makes this explicit.