As a means of securing faster tax credits on assets, the concept of accelerated depreciation has long been a common practice. Essentially, accelerated depreciation allows the owner to take larger write-offs for the depreciation of selected goods and properties early on, with the understanding that the same goods and properties will not be eligible for the same level of depreciation in later years. Here are some basics on the way depreciation works, and how accelerated depreciation can sometimes make a lot of sense.
The basic idea behind depreciation is that as any good or property ages, there is some wear and tear that could very well make the item of less value. Depreciation takes into account that decreased worth and allows businesses to register a fair and equitable current value when assessing the overall net worth of the company. That amount of depreciation is often allowed as a tax deduction for that particular calendar year.
Accelerated depreciation simply allows the owner to take advantage of greater tax deductions now, rather than later. What this means is that the owner will not be using what is known as straight line depreciation. Straight line methods would mean the owner is choosing to go with average depreciation amounts, rather than the accelerated type. This will mean that in later years, the owner will not be able to claim any depreciation on the asset. However, it does mean that the cumulative impact on using the accelerated amount as a tax shield for a year or two may in fact be very good for the company in the short term.
As an example, a company purchases a new delivery van. The first year, the company will have the option of declaring standard depreciation on the vehicle and using that as a tax deduction, or declaring an accelerated deduction and using up most of the allowed depreciation for the next several years. While this will mean the van will not generate a tax deduction in later years, it does mean that the size of the actual deduction the first year may be enough to partially cover the expenses of purchasing the van. Overall, this means the operating expenses for the calendar year will be easier to cover. The end result is that the company gets a nice tax break and a new van, all within one taxable year.
Care should be taken when using the principle of accelerated depreciation. While on the surface the concept may seem a very appealing way to get the most out of properties and assets on the front end, there is also the possibility that the practice could result in financial problems in later years. Before making a decision to utilize accelerated depreciation in order to generate a tax deduction, it is always a good idea to run a few accounting scenarios and see what set of circumstances may be put into motion as a result of using the accelerated depreciation model. It may not be in the best interests of the company to utilize accelerated depreciation on the front end. Consultation between financial officers and a quality accounting firm will help make it clear whether or not the use of accelerated depreciation is in the best interest of the corporation.