The business world is complex, competitive and enormously taxing both from a monetary standpoint as well as from a managerial/emotional/physical standpoint for many business owners, especially small business owners, like many advisors’ clients. Therefore, in this article we’re going to specifically discuss one aspect of the monetary taxing side, which I believe is mostly unknown to the average business owner.
The issue relates to depreciation, which is defined as a reduction in the value of an asset with the passage of time, due in particular to wear and tear of the asset over time.
What most business owners don’t know is that, subject to IRS code, any depreciable asset – whether actually depreciated or not – legally has its basis adjusted for the allowed or allowable depreciation, regardless of the actual tax benefit received while placed in service. So what does that mean exactly?
According to IRS Publication 946: A basis adjustment must reduce the basis of the property by the depreciation allowed or allowable, whichever is greater.
Depreciation allowed is depreciation actually deducted when filing your taxes (from which you received a tax benefit). Depreciation allowable is depreciation you’re entitled to deduct, but didn’t necessarily deduct for tax purposes.