What Is Depreciation and Why It Matters for Taxes

When you buy a business asset (equipment, vehicles, furniture, computers), the IRS does not let you deduct the full cost in the year you buy it. Instead, you spread the deduction over the asset's useful life. This is depreciation.

Depreciation reduces your taxable income each year, which means you pay less in taxes. For small business owners, understanding your depreciation options can save you thousands of dollars annually.

Depreciation Methods Explained

Straight-Line Depreciation

The simplest method. You deduct the same amount every year.

Annual Depreciation = (Asset Cost - Salvage Value) / Useful Life

A $10,000 machine with a $1,000 salvage value and a 5-year life depreciates at $1,800 per year. Predictable and easy to plan around.

Section 179 Deduction

Section 179 lets you deduct the full purchase price of qualifying assets in the year you buy them, up to the annual limit ($1,220,000 for 2026). This is a major tax benefit for small businesses.

Qualifying assets include:

• Equipment and machinery
• Vehicles (with limits for passenger vehicles)
• Computers and software
• Office furniture
• Certain building improvements

The catch: your total equipment purchases for the year cannot exceed $3,050,000, or the deduction starts to phase out.

MACRS (Modified Accelerated Cost Recovery System)

MACRS is the IRS default depreciation method for business assets. It front-loads deductions so you get larger write-offs in early years and smaller ones later.

Common MACRS recovery periods:

• 3-year: Tractor units, racehorses, certain manufacturing tools
• 5-year: Vehicles, computers, office equipment, appliances
• 7-year: Office furniture, agricultural structures
• 10-year: Water transportation equipment, some agricultural assets
• 15-year: Land improvements, certain retail improvements
• 20-year: Farm buildings, municipal sewers

Bonus Depreciation

Bonus depreciation allows you to deduct a percentage of an asset's cost in the first year on top of regular MACRS depreciation. The rate has been phasing down since 2023:

• 2024: 60%
• 2025: 40%
• 2026 (current year): 20%
• 2027 and after: 0% (bonus depreciation expires entirely)

At 20%, bonus depreciation still provides a meaningful first-year deduction, but this is the last year it offers any benefit. If you are planning a major equipment purchase, buying before January 2027 locks in the remaining 20% bonus. After that, the deduction drops to zero.

The remaining cost after the bonus deduction is then depreciated using MACRS over the asset's recovery period.

Which Method Should You Choose?

• Need the biggest tax break this year? Section 179 or bonus depreciation
• Want predictable deductions over time? Straight-line
• Default IRS method? MACRS
• Buying a vehicle? Check the annual vehicle deduction caps, as they limit all methods

Many small businesses combine Section 179 and bonus depreciation to maximize first-year deductions, then use MACRS for the remainder.

Real Estate Depreciation

Real estate depreciation works differently from equipment and vehicles. The IRS requires property owners to spread the deduction over a much longer period because buildings lose value slowly.

Residential rental property depreciates over 27.5 years using straight-line depreciation. If you buy a rental house for $200,000 (excluding the land value, which is not depreciable), your annual depreciation deduction is about $7,273. At a 24% tax rate, that saves you roughly $1,745 per year in federal taxes.

Commercial property depreciates over 39 years. A $500,000 commercial building (again, excluding land) gives you an annual deduction of about $12,821.

Key things to know about real estate depreciation:

1. Land is never depreciable. You must separate land value from building value. A common approach is using the county tax assessment ratio. If the county says 25% of your property value is land, you depreciate only the remaining 75%.

2. Capital improvements to the property (new roof, HVAC system, kitchen renovation) are depreciated separately. Residential improvements follow the 27.5-year schedule. Some improvements qualify for shorter recovery periods under cost segregation.

3. Cost segregation studies let you reclassify parts of a building (flooring, fixtures, landscaping) into shorter MACRS categories (5, 7, or 15 years), accelerating your deductions significantly. This is especially valuable for properties worth $500,000 or more.

4. Depreciation recapture applies when you sell. The IRS taxes your accumulated depreciation at 25% (Section 1250 recapture). Plan for this when calculating your exit strategy.

If you own rental property, use the Rental Property Analyzer to factor depreciation into your cash flow analysis. For BRRRR deals, the BRRRR Calculator shows how depreciation affects your after-tax returns.

Tax Savings Estimate

The calculator multiplies your annual depreciation by your marginal tax rate to show estimated tax savings per year. If your depreciation is $10,000 and your tax rate is 25%, you save roughly $2,500 in taxes that year.

These savings are real dollars. Use them to plan cash flow, reinvest in the business, or pay down debt.

A Practical Example

You buy a $30,000 work truck. Using Section 179, you can deduct the full $30,000 this year (subject to vehicle limits). At a 24% tax rate, that saves you $7,200 in federal taxes right away.

Without Section 179, using MACRS over 5 years, your first-year deduction would be $6,000 (20% of $30,000), saving you $1,440 in year one.

The difference: $5,760 more in your pocket this year with Section 179.