What depreciation is and how it affects your money

Depreciation is the decline in value of something you own over time. For tax purposes, it means you can deduct a portion of what you paid for certain assets — like a car, rental property, or business equipment — each year, reducing the income you report to the IRS. This matters to lower-income households because depreciation deductions can lower your tax bill, and understanding how it works prevents you from missing deductions you are may have access to to claim.

The IRS allows you to spread the cost of an asset over several years rather than deducting the full amount in the year you buy it. The number of years depends on what you own: a car is typically depreciated over five years, a house over 27.5 years if you rent it out, and business equipment over three to seven years depending on the type. You cannot depreciate something you use only for personal reasons — your primary home, for example — but you can depreciate a rental property, a vehicle used for work, or tools and equipment for self-employment.

Key Takeaways

  • Depreciation lets you deduct part of an asset's cost each year on your taxes, which can lower the income you report and reduce what you owe.
  • You can only depreciate assets used for business, rental income, or work — not personal items like your primary home or personal car.
  • Different assets depreciate over different time periods: cars over five years, rental homes over 27.5 years, and business equipment over three to seven years.
  • If you are self-employed or own rental property, tracking depreciation correctly can save you hundreds of dollars per year in taxes.
  • When you sell a depreciated asset, you may owe tax on the gain, so understanding depreciation now prevents surprises later.

When you can claim depreciation on your taxes

Depreciation deductions are available only for assets used to produce income or for business purposes. If you are self-employed, you can depreciate tools, vehicles, computers, and equipment used in your work. If you own a rental property, you can depreciate the building itself (though not the land it sits on) and any appliances or improvements you make. If you use part of your home as a dedicated office for self-employment, you can depreciate that portion of the building and the furniture in it.

You cannot depreciate items used only for personal reasons. Your primary residence does not may have access to, even if you own it outright. A car you drive for personal errands does not may have access to. However, if you use a vehicle partly for work and partly for personal use, you can depreciate only the work portion. The same applies to a home office: you can depreciate only the square footage you use exclusively for business.

To claim depreciation, you must own the asset outright or have a lease or purchase agreement in place. You cannot depreciate something you rent or borrow. You also cannot depreciate land itself — only structures and improvements on it. If you buy a rental property for $200,000 and the land is worth $50,000, you can depreciate only the $150,000 building portion.

How to calculate depreciation using the standard method

The most common way to calculate depreciation is the straight-line method, which divides the cost of an asset evenly across its useful life. To use it, you need three numbers: the cost of the asset, its salvage value (what it will be worth at the end of its useful life), and the number of years you will depreciate it.

Here is a simple example. You buy a used van for $15,000 to use in your plumbing business. The IRS says a vehicle depreciates over five years. You estimate it will be worth $3,000 at the end of five years. Subtract the salvage value from the cost: $15,000 minus $3,000 equals $12,000. Divide by five years: $12,000 divided by five equals $2,400 per year. You can deduct $2,400 from your business income each year for five years.

For rental property, the calculation is similar but the timeline is much longer. If you buy a rental house for $250,000 and the building (not the land) is worth $200,000, you divide $200,000 by 27.5 years, which gives you roughly $7,273 per year in depreciation deductions. You claim this on Schedule E of your tax return each year you own the property.

The IRS publishes tables showing the useful life of different types of assets. Business furniture is typically seven years, computers three years, and manufacturing equipment five to seven years depending on the type. If you are unsure about the useful life of something you own, the IRS website or a tax professional can tell you the correct period.

What happens when you sell a depreciated asset

When you sell something you have been depreciating, the IRS taxes you on the difference between what you sell it for and what you have already deducted. This is called recapture. If you depreciated $12,000 on a van and then sold it for $8,000, you would owe tax on the $4,000 difference — even though you sold it for less than you paid.

Here is why: you already deducted $12,000 from your income over five years, which lowered your tax bill. When you sell the van, the IRS wants to recapture some of that tax benefit. The amount you owe depends on your tax bracket. If you are in the 12 percent bracket, you would owe roughly $480 on that $4,000 gain. If you are in the 22 percent bracket, you would owe roughly $880.

For rental property, recapture works the same way but the tax rate is higher. The IRS taxes depreciation recapture on rental property at 25 percent, regardless of your regular tax bracket. If you depreciated $100,000 on a rental house and sold it for a $50,000 gain, you would owe 25 percent of the $100,000 in depreciation recapture tax — $25,000 — plus regular capital gains tax on the $50,000 gain. This is why it is important to understand depreciation before you buy a rental property.

Depreciation and lower-income households: where it helps most

For lower-income people who are self-employed, depreciation can be the difference between owing taxes and getting a refund. If you earn $35,000 in self-employment income but can deduct $8,000 in depreciation on tools and equipment, you report only $27,000 to the IRS. This lowers your self-employment tax (which is 15.3 percent on net earnings) and your income tax. On $8,000 in depreciation, you might save $1,200 to $1,500 in total tax.

For lower-income renters, depreciation does not apply directly — you cannot depreciate an apartment you rent. However, if you are considering buying a rental property as an investment, understanding depreciation helps you decide whether it makes financial sense. The depreciation deduction can offset rental income and reduce your tax bill, but you will owe recapture tax when you sell, so the benefit is not permanent.

If you receive income from a side business — freelance work, selling items online, childcare, or repairs — and you buy equipment or tools for that business, depreciation lets you spread the cost over several years instead of deducting it all at once. This is especially helpful if your income varies year to year, because you can claim depreciation even in years when your business income is low.

Common mistakes to avoid when claiming depreciation

One of the most common mistakes is depreciating something that should not be depreciated. You cannot depreciate land, inventory (items you sell), or anything used only for personal reasons. If you claim depreciation on your primary home or personal car, the IRS will disallow it and you may face penalties. Always ask yourself: Is this asset used to produce income or for business? If the answer is no, you cannot depreciate it.

Another mistake is failing to keep records. The IRS requires you to document what you bought, when you bought it, how much you paid, and how you use it. If you cannot show proof that a vehicle is used for business, you cannot claim depreciation on it. Keep receipts, invoices, and a log of business use. For a vehicle, track the miles you drive for business versus personal use.

A third mistake is not adjusting your basis when you make improvements. If you buy a rental property for $200,000 and then spend $30,000 on a new roof, your depreciable basis increases to $230,000. Failing to add improvements means you miss depreciation deductions you are may have access to to claim. Keep records of all repairs and improvements and add them to your basis.

How to report depreciation on your tax return

If you are self-employed, you report depreciation on Form 4562 (Depreciation and Amortization), which you attach to your Schedule C (Profit or Loss from Business). You list each asset, its cost, the date you placed it in service, the method you used to calculate depreciation, and the amount you are deducting for the year. The total depreciation amount then goes on your Schedule C, reducing your net business income.

If you own rental property, you report depreciation on Schedule E (Supplemental Income and Loss). You list the property, the depreciable basis, the useful life, and the depreciation deduction for the year. Like Schedule C, this reduces your net rental income and lowers your tax bill.

If you are not sure how to fill out these forms, a tax professional or a free tax preparation service (like VITA, which serves households earning under $60,000) can help you. Many lower-income people may have access to for free tax preparation through VITA sites in their community, and these volunteers are trained to identify depreciation deductions you might miss.

Frequently Asked Questions

Can I depreciate a car I use for both personal and business driving?

Yes, but only for the business portion. If you drive 60 percent for business and 40 percent for personal use, you can depreciate only 60 percent of the car's cost. You must keep a log of business miles versus personal miles to prove this split to the IRS. Many people use the standard mileage rate instead, which is simpler — you deduct a set amount per business mile rather than calculating depreciation.

What if I buy used equipment instead of new?

Depreciation works the same way for used equipment as for new. You depreciate based on what you paid for it, not its original cost when it was new. If you buy a used computer for $400, you depreciate $400 over three years, regardless of what the original owner paid for it.

Do I have to claim depreciation every year?

Once you start depreciating an asset, you should claim it every year until it is fully depreciated or you sell it. If you skip a year, the IRS may still expect you to have claimed it, which can create problems when you sell the asset. It is easier to claim depreciation consistently than to correct it later.

What is the difference between depreciation and a deduction?

A deduction is an amount you subtract from your income to lower your tax bill. Depreciation is one type of deduction — it spreads the cost of an asset over time. Other deductions, like office supplies or rent, are claimed all at once in the year you pay for them. Depreciation is a deduction that happens over multiple years.

Can I claim depreciation if I am not sure whether I will keep the asset for its full useful life?

Yes. You claim depreciation based on the IRS useful life, not on how long you actually keep the asset. If you depreciate a vehicle over five years but sell it after three years, you stop claiming depreciation at that point. You do not have to predict in advance how long you will own something.