Understanding depreciation: book vs tax
Depreciation spreads the cost of equipment, vehicles and buildings over the years you use them. Done well it saves tax. Done badly it creates errors in every future return and in the gain when you sell. Here is how it works.
What depreciation is
When you buy an asset that will last more than a year, you generally cannot deduct the whole cost at once. Instead you deduct it over time. This is called depreciation (for most tangible property), or amortization (for intangibles such as software and startup costs).
Two sets of numbers: book and tax
| Book depreciation | Tax depreciation | |
|---|---|---|
| Used for | Financial statements, lenders, investors (GAAP) | Your tax return |
| Rules | Choose a method and useful life that fit how the asset is used (often straight-line) | Set by the tax code: MACRS recovery periods, Section 179, bonus depreciation |
| Speed | Usually slower and steadier | Often faster, especially with Section 179 and bonus depreciation |
| Result | Book basis (cost minus accumulated book depreciation) | Tax basis (cost minus tax depreciation taken) |
Common tax methods
- MACRS: the standard system. Assets are placed in classes (for example 5-year for computers and cars, 7-year for office furniture and equipment, 27.5 years for residential rental buildings and 39 years for commercial buildings) with set percentages by year.
- Section 179: lets you deduct the cost of qualifying equipment and software in the first year, up to a yearly limit that is phased out for large purchases.
- Bonus depreciation: an additional first-year deduction for qualifying property. The percentage and eligibility have changed in recent years, so we check the current law for each purchase.
- Vehicle rules: passenger vehicles have yearly limits, and listed property needs usage records.
A simple example
A business buys $50,000 of equipment. On the books it uses straight-line over five years: $10,000 a year. For tax, depending on the elections available, it may deduct much more (even the whole amount) in year one. The difference is temporary: it reverses over time, and it creates a "deferred tax" item on the financial statements.
Why you must track both bases
- Gain or loss on sale is figured from tax basis, not book basis.
- Depreciation recapture: when you sell, part of the gain can be taxed as ordinary income (Sections 1245 and 1250).
- State differences: many states do not follow federal bonus depreciation or Section 179 limits, so there can be a third set of numbers: state basis.
- Financial statements and loans use book numbers; the tax return uses tax numbers. They must reconcile.
- Errors compound. A missed asset or wrong life affects every later year.
Our depreciation tracking (coming soon)
We are preparing a separate website and subscription service to track depreciation for you: a fixed asset register with book basis, federal tax basis and state tax basis, yearly schedules for each, disposals and recapture, and year-end reports ready for your return and your financial statements.
If you would like to hear when it launches, send us a message and select "Depreciation tracking (waitlist)".
Common questions
Can I deduct the full cost of equipment right away?
Sometimes, using Section 179 or bonus depreciation. The rules and limits change, so we check the law for the year you buy the asset and compare the benefit against future years.
Why does my accountant keep two depreciation schedules?
Book depreciation follows accounting standards and tax depreciation follows the tax code. The two differ in timing, and both are needed for accurate financial statements and tax returns.
What is depreciation recapture?
When you sell a depreciated asset for more than its tax basis, part of the gain can be taxed as ordinary income up to the depreciation you took. Planning before a sale can reduce surprises.
General information for 2026, not advice for your situation. Rules change and have exceptions. Talk to us before you act.
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