How to Depreciate Equipment (Small Business Guide)

Depreciation is an accounting concept that can feel obscure until your business makes its first equipment purchase. Suddenly, you realize this equipment has a long tail, and that obscure concept, depreciation, can help. For example, instead of deducting the full $15,000 cost of a machine all at once, you spread the expense over its useful life, matching the cost to the revenue it helps generate. 

Getting depreciation right is crucial for your small business, as it directly reduces taxable income and impacts your cash flow. Use this guide to learn how to depreciate equipment, along with other considerations to ensure you're taking the best action for your business. 

Key takeaways

• Depreciation allocates cost over time. The IRS treats machinery, vehicles, computers, and other tangible assets as long-term property that loses value due to wear and tear or obsolescence. Depreciation is the process of spreading the cost over the asset’s life.

• Only business‑use property with a determinable life qualifies. To depreciate equipment, you must own it, use it for business purposes, and expect it to last more than a year. Land is never depreciable.

• Your cost basis matters. Depreciation starts with the asset’s basis—its purchase price plus taxes, shipping, and installation, minus discounts. Allocations are needed when an item is partially for personal use or includes both depreciable and non‑depreciable components.

• Several methods exist. Straight line depreciation spreads cost evenly; accelerated methods (declining balance and sum‑of‑the‑years’ digits) front‑load deductions; units of production bases depreciation on usage. Modified Accelerated Cost Recovery System (MACRS) tables govern tax calculations.

• Section 179 and bonus depreciation accelerate write‑offs. Qualifying equipment can be fully expensed in the year of purchase up to $1,250,000 in 2025, with additional bonus depreciation available for certain assets.

• Keep meticulous records. You need documentation showing cost, date placed in service, useful life, and depreciation schedules. Improper or missed deductions reduce your basis and can lead to higher taxable gains later.

What Is Equipment Depreciation?

When you buy equipment for your business, such as a forklift for your warehouse, a fleet of delivery vans, or a new server rack, its value declines as you use it. Accounting rules require that you match the expense of using an asset with the revenue it generates, rather than deducting the whole cost in the year you buy it. Depreciation is the mechanism for that matching.

The IRS describes depreciation as “an annual income tax deduction that allows you to recover the cost or other basis of certain property over the time you use the property”. In other words, it’s a way to break up a large purchase into smaller, annual deductions. You can depreciate tangible property such as machinery, equipment, furniture, and vehicles, but there are eligibility requirements. You must own the property, use it in your business or income‑producing activity, have a determinable useful life, and expect it to last more than one year. While you can depreciate a building or improvements on land, the land itself never wears out and is therefore not eligible for depreciation as a result. 

Depreciation is also a non‑cash expense. It doesn’t reflect the amount of money leaving your bank account each year. Instead, it reduces your taxable income and, by extension, your tax bill. This improves cash flow by allowing you to retain more of your earnings, especially when combined with accelerated depreciation methods.

Determining Equipment Cost Basis and Useful Life

Calculating cost basis

Depreciation calculations begin with the depreciable basis, which represents the initial investment in the equipment. This includes:

• The purchase price plus sales tax

• Delivery fees

• Installation costs 

• Other expenses to get the asset ready for use

You should subtract any discounts or rebates received. Only the portion relating to the equipment itself is depreciable; if you purchased land with a building, you must allocate a portion of the price to the land (non‑depreciable) and the remainder to the building (depreciable).

Special situations require additional care:

• Gifts and inheritances. When you receive equipment as a gift, your basis is generally the donor’s adjusted basis (their original cost minus depreciation claimed). For inherited property, your basis is usually fair market value on the date of death. This determines the depreciation you can claim.

• Conversion from personal use. If you convert a personal vehicle or tool to business use, your basis is the lesser of its fair market value or your original cost. You must allocate basis and deductions according to the percentage of business use.

• Mixed‑use or combined purchases. When purchasing a bundle that includes both depreciable and non-depreciable items (for example, land and equipment) or items with different useful lives, allocate the total cost proportionally. Similarly, if you use equipment partly for personal purposes (for example, a computer used 70% for business), you can only depreciate the business-use portion of the equipment.

Estimating salvage value and useful life

Next, you must estimate the equipment’s salvage value (also called residual value)—what you expect it to be worth when its business life is over. Salvage value reduces the amount depreciated; the higher the salvage value, the lower the total depreciation expense. Most businesses make reasonable estimates based on:

• Market data

• Manufacturer guidance

• Industry norms

However, some businesses choose a salvage value of zero if they plan to use the asset until it’s considered worthless.

The useful life refers to the number of years the asset is expected to remain productive in your business. Longer useful lives result in lower annual depreciation. The IRS provides class lives and recovery periods for various asset types under MACRS. For example, computers have a five-year class life, while residential rental properties have a 27.5-year life. However, the IRS guidance is just a starting point; you should consider your specific situation. Intensive usage, poor maintenance, rapid technological change, or unfavorable industry conditions may shorten the useful life, while high-quality maintenance can extend it. Remember that to depreciate property, you must anticipate that it will last more than one year. 

Refer to IRS Publication 946 and industry standards for additional guidance on estimating useful life. 

Choosing a Depreciation Method

Once you know the basis, salvage value, and useful life, you must decide how to allocate depreciation across the years. There are four common methods used in financial accounting, and for tax purposes, these conceptual methods underlie IRS MACRS.

1. Straight line depreciation (SL). The simplest method, straight line, spreads the depreciable base evenly over the asset’s useful life. The formula for annual depreciation is:Annual SL depreciation = (Cost basis – Salvage value) ÷ Useful life

2. Declining balance methods. Accelerated methods front‑load deductions. The most common are double‑declining balance (DDB) and 150% declining balance. Under DDB, you double the straight line rate and apply it to the asset’s remaining book value each year; salvage value is not subtracted upfront. For the $10,000 machine with a five‑year life, the straight line rate is 1/5 = 20%, and the double‑declining rate is 40%. The first year’s depreciation is $10,000 × 40% = $4,000. In subsequent years, you multiply the remaining book value by the same rate until the book value reaches salvage value.

3. Sum‑of‑the‑years’ digits (SYD). Another accelerated method, SYD, assigns a higher weight to earlier years. Add up the digits of the asset’s useful life (for a five‑year life, 5 + 4 + 3 + 2 + 1 = 15). In the first year, you take 5/15 of the depreciable base, in the second year 4/15, and so on.

4. Units of production. If your equipment’s wear is tied to usage rather than time, the units of production method may be more appropriate. First estimate total expected output (hours used, miles driven, units produced). Then calculate a depreciation rate per unit: (Cost – Salvage value) ÷ Total expected units. Each year’s depreciation equals the number of units consumed multiplied by the rate. This method is particularly suitable for vehicles and machinery that have varying usage patterns.

MACRS, mandated for most tax purposes, is a hybrid system that uses declining balance rates for the first part of the asset’s life and then switches to straight line. It also applies conventions (half‑year, mid‑quarter, or mid‑month) that affect the first‑year deduction. To properly apply MACRS, consult IRS tables or work with a professional. Understanding the conceptual methods above, however, helps you see why depreciation can accelerate deductions or spread them evenly.

Step‑by‑Step Guide to Depreciate Equipment

Depreciating equipment involves more than plugging numbers into a formula. Follow these seven steps to ensure compliance and optimize your deductions.

1. Identify qualifying property. Confirm that the asset is tangible, that you own it, and that it is used in your trade or business with an expected life greater than one year. The IRS prohibits depreciation of personal property or land.

2. Determine cost basis. Gather invoices, receipts, and proof of payment. Add the purchase price, sales tax, shipping, installation, and other costs necessary to prepare the asset for use. Subtract any discounts or trade‑in credits.

3. Estimate salvage value and useful life. Consider market trends, manufacturer guidance, your maintenance plan, and IRS class lives. Set a salvage value (even zero) and determine how long you expect to use the equipment.

4. Choose a depreciation method. Weigh the trade‑offs: straight line offers simplicity; accelerated methods free up cash in early years; units of production align deductions with actual usage. If you need assistance determining the best method, 1-800Accountant's tax advisory team can explain MACRS tables and how they interact with your current tax strategy.

5. Calculate annual depreciation. Use the chosen method’s formula. For example, suppose you purchased a $10,000 lathe with a $2,000 salvage value and a five‑year life. The table below compares annual deductions under the straight line, double‑declining balance, and units of production methods (assuming expected total output of 10,000 hours and 2,500 hours used each of the first two years).

*Units of production method assumes the machine produces 2,500 hours each year; total depreciation equals $8,000 ($10,000 – $2,000) spread evenly across production hours.

1. Record depreciation. Post a journal entry debiting Depreciation Expense and crediting Accumulated Depreciation. Depreciation expense appears on your income statement, reducing net income, while accumulated depreciation appears on the balance sheet as a contra asset that lowers the book value of equipment.

2. File Form 4562. Use IRS Form 4562, Depreciation and Amortization (Including Information on Listed Property), to claim depreciation and Section 179 deductions. You must file this form in any year you depreciate property or elect Section 179. Keep records to prove the date placed in service, basis, depreciation method, recovery period, and percentage of business use.

Depreciation Methods Compared: Illustrative Examples

The table above illustrates how various methods yield distinct patterns of deductions. 

• Under straight line, you deduct the same $1,600 every year. 

• Double‑declining balance provides a $4,000 deduction in year 1 (40 % of $10,000) and declines thereafter, delivering a substantial cash flow benefit early on. 

• The units of production method ties depreciation to actual hours of use—if you work the machine harder one year and less the next, your tax deduction follows.

Accelerated methods have pros and cons. They reduce taxable income more quickly, which can free up cash to reinvest in growth or offset a year with higher profits. However, you sacrifice deductions in later years; by year 5, the double‑declining balance deduction is only $576. Straight line, on the other hand, provides stability and predictability, which may help with financial planning and is often used for financial reporting. When deciding, consider your cash flow needs, the asset’s wear pattern, and any plans to sell or trade the equipment before its end of life.

Tax Deductions Beyond Standard Depreciation

Section 179 deduction

Congress introduced Section 179 to encourage businesses to invest in equipment by allowing them to deduct the entire cost in the year it’s placed in service, rather than depreciating it over several years. For tax years beginning in 2025, the maximum Section 179 deduction is $1,250,000, and the deduction phases out dollar‑for‑dollar when total qualifying property placed in service exceeds $3,130,000. Sport‑utility vehicles have a separate, lower cap. Section 179 applies to tangible personal property such as:

• Machinery

• Equipment

• Computers

• Off‑the‑shelf software

To qualify, the property must be used more than 50% for business and must be acquired by purchase (gifts and inheritances do not qualify). You cannot claim more Section 179 deduction than your taxable business income for the year; any excess can be carried forward.

Section 179 is powerful for businesses with significant profits in the year of purchase. For example, if your business buys $200,000 of equipment and has $400,000 of taxable income, Section 179 lets you deduct the entire $200,000 immediately (subject to the limits), potentially reducing your tax bill by tens of thousands of dollars. However, using Section 179 means giving up future depreciation deductions, so you need to evaluate whether immediate expensing aligns with your long‑term tax strategy. 

1-800Accountant's affordable small business tax service can help you decide and ensure you don’t run afoul of the rules.

Bonus depreciation and MACRS

If you exceed the Section 179 limit or have property that doesn’t qualify, you may take advantage of bonus depreciation, also known as the special depreciation allowance. For assets placed in service after December 31, 2024, and before January 1, 2026, the bonus depreciation percentage is 40%. Bonus depreciation can be applied after Section 179; you simply reduce the asset’s basis by the Section 179 amount and then multiply by the bonus percentage to determine the additional deduction. Unlike Section 179, bonus depreciation can create or increase a net operating loss.

After considering Section 179 and bonus depreciation, you use MACRS tables to calculate the remaining depreciation. MACRS assigns property to recovery periods (3‑, 5‑, 7‑, 15‑, 27.5‑, and 39‑year classes) and applies declining balance rates that switch to straight line at a certain point. The system also employs conventions to determine the amount of depreciation that can be claimed in the year of purchase and disposal.

MACRS is complex; if you are not comfortable with the tables, our tax professionals can help.

Record‑Keeping, Compliance and Adjustments

Depreciation is one area where meticulous record‑keeping pays off. Keep the following documents on file:

• Proof of acquisition and cost. Maintain purchase agreements, invoices, canceled checks, and bank statements that show the amount paid for the equipment and the date of payment.

• Depreciation schedules and log books. Track each asset’s basis, method, useful life, depreciation for each year, and accumulated depreciation.

• Usage and maintenance records. For units of production or mixed-use assets, keep records of the hours used, miles driven, or units produced. Maintenance logs support useful life estimates and salvage value assumptions.

• Percentage of business use. If you use an asset partially for personal reasons, document how you determined the business‑use percentage and update it annually.

The IRS requires you to keep records supporting the depreciation deduction until you dispose of the assets. Depreciation begins when the asset is placed in service and ends when its cost has been fully recovered, or when it is retired or disposed of.

Adjustments are another critical aspect. When you improve or add to equipment, the cost is usually added to the basis and depreciated over the remaining life. Casualty losses and trade-ins can alter the basis and depreciation schedule. Be aware that if you fail to claim allowable depreciation, the IRS still reduces your basis by the amount you should have deducted, which increases your taxable gain when you sell the asset.

While land is not depreciable, land improvements closely associated with a building may be.

Industry‑Specific Considerations

Depreciation is not one‑size‑fits‑all. Different industries wear out and replace equipment at different rates. Here are a few prominent examples:

• Construction and real estate. Bulldozers, excavators, and cranes are often heavily used and frequently become obsolete as technology advances. Accelerated methods, such as double-declining balance or Section 179 deductions, can provide early tax relief, helping contractors reinvest in newer, more efficient equipment. Real estate professionals can depreciate buildings over 27.5 or 39 years, but might use Section 179 for office equipment and vehicles.

• E‑commerce and technology. Computers, servers, and software have relatively short lifecycles. Using accelerated depreciation or bonus depreciation ensures that your tax deductions keep pace with the rapid obsolescence of technology. Since software updates occur frequently, many e-commerce companies expense off-the-shelf software using Section 179 or bonus depreciation.

• Trucking and transportation. Trucks and vans accumulate mileage quickly. Units of production or units of activity methods tie depreciation to actual miles driven, making deductions better reflect wear. Fleet managers also rely on Section 179 and bonus depreciation when replacing multiple vehicles in a single year. For more on deducting vehicle expenses, see our guide to small business car deductions.

• Professional services. Lawyers, consultants, accountants, and medical practices typically use office furniture, computers, and diagnostic equipment that wear evenly over time. Straight line depreciation may suffice for most assets, providing predictable deductions that align with long‑term budgeting.

In all cases, pairing with a CPA, EA, or tax professional who understands your industry ensures you choose depreciation schedules that reflect real‑world wear patterns and cash flow needs. 1‑800Accountant matches you with professionals experienced in your sector to ensure both tax compliance and strategy are optimized.

Maximizing Benefits with Professional Support

Equipment depreciation is a strategic tool that reduces taxable income and improves cash flow, but requires careful calculations, documentation, and planning. 

While depreciation formulas are straightforward, the decisions underlying them can have long‑term consequences. Underestimating salvage value or overestimating useful life can lead to distorted financial statements. Electing Section 179 or bonus depreciation may yield immediate savings, but it reduces deductions in future years. Failing to depreciate assets correctly not only forfeits tax benefits but also can result in penalties or overstated gains when you sell the equipment.

If you’re ready to get the most out of your equipment investments and avoid depreciation pitfalls, schedule a free 30-minute consultation with 1-800Accountant, America's leading virtual accounting firm, today.

FAQs About Depreciating Equipment

What assets can be depreciated?

You can depreciate tangible property such as machinery, vehicles, computers, office furniture, fixtures, and buildings used in your trade or business. You must own the property, used for business or production of income, have a determinable useful life, and last more than one year.

What property cannot be depreciated?

Land and particular property, such as inventory or property used for personal activities, cannot be depreciated. Assets that are placed in service and disposed of in the same tax year are not depreciated.

How do I decide which depreciation method to use?

Consider the pattern of wear and the cash flow needs of your business. Straight line provides simplicity and steady deductions; accelerated methods yield larger deductions early, which can free up cash for investment; units of production align depreciation with usage. Industry norms and tax considerations also play a role. For example, the manufacturing industry typically embraces the units of production method of depreciation. When in doubt, consult a tax professional.

What happens if I use an asset for both business and personal purposes?

You may only depreciate the portion of the asset that is used for business purposes. For example, if you use a computer 70% for your business and 30% for personal tasks, you can only claim depreciation on 70% of its basis. You must document how you determined the business‑use percentage.

How do I change depreciation methods or correct mistakes?

Changing depreciation methods typically requires approval from the IRS. To correct a depreciation error, you may need to file an amended return or IRS Form 3115, Application for Change in Accounting Method. Due to the complexity of the rules, professional guidance is recommended. 1‑800Accountant’s tax professionals can help you correct past mistakes while ensuring ongoing compliance.

Get Support on Depreciation From 1-800Accountant

Depreciating equipment is an opportunity to manage cash flow, plan for future capital expenditures, and reduce your tax burden. By understanding the concepts of basis, salvage value, useful life, and depreciation methods, you can make informed decisions that align with your business goals. 

With support from experienced professionals at 1-800Accountant, you can ensure compliance and maximize deductions, allowing you to reinvest in your business and stay competitive with a suite of affordable, tax-deductible solutions.