What Does Depreciation Mean to Your Construction Business?
Each time your construction company prepares its financial statements, you can record a depreciation expense. This spreads out the initial price of an asset over the course of its useful life. By taking a deduction for depreciation on your business's tax return, you can recover the cost of certain property or equipment.
Asset depreciation applies to any business expense that has a useful life of more than one year, such as company cars, computers, desks, and equipment. Even office space can count. Anything that may lose value over time because of decay, wear, or obsolescence will depreciate. These items are known as capital assets.
Depreciation indicates how much of an asset's value has been used up. Your construction company can deduct the cost of the tangible asset as a legitimate expense, in accordance with IRS rules about how and when the deduction may be taken, based on what the asset is and how long it will last.
If you sell a capital asset during its useful life, you are subject to taxes on the sale. If you sell it for more than you paid for it, including any improvements you may have made to it, you're subject to capital gains tax. If you take a loss, you can deduct the amount of value lost as a business expense.
Throughout the years, you will make critical assumptions about how to expense depreciation. This will be based on the method and rate of depreciation and the useful life of the asset. You also may calculate the scrap value. These calculations can be done by a straight-line or accelerated method.
Also known as uniform depreciation, straight-line depreciation is the most frequently used method of depreciating new equipment for financial statements. Here, the equipment loses an equal part of its total value every year of its life. For your tax return, your accountant most likely will use a tax-approved depreciation formula to gain the largest deduction for you to minimize your tax burden.
The accelerated method writes off depreciation costs more quickly to minimize taxable income. Companies use the double-declining balance method, essentially doubling the rate.
Your choice of depreciation method will affect your construction company's income statement and balance sheet in the short term. The method chosen affects earnings. For example, intangible assets, such as brands and intellectual property, use amortization. Natural resources, like minerals, timber, and oil reserves, use depletion.
If you have questions about depreciation when it comes to your construction business, give us a call today.