Depreciating Used Equipment: Is It Possible and How Does It Work?

Depreciating used equipment is a viable option for some businesses, but it's not a straightforward process. The IRS allows businesses to depreciate used equipment, but only if it's acquired with a purchase agreement or lease.

The used equipment must be placed in service and have a useful life of more than one year to qualify for depreciation. This means that if you acquire a used piece of equipment and use it for less than a year, you won't be able to depreciate it.

You can't depreciate used equipment if you simply rent or lease it, but if you purchase a used piece of equipment with a purchase agreement, you can depreciate it. The IRS considers this a capital asset, allowing you to claim depreciation on its value.

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Depreciation is the reduction in value of an asset over time due to wear and tear, obsolescence, or other factors.

It's a fundamental concept in accounting and finance, and it's used to calculate the cost of owning and using assets.

The IRS allows businesses to depreciate assets over a specific period, which can range from 5 to 20 years depending on the type of asset.

Depreciation can be calculated using various methods, including the straight-line method, which assumes a constant rate of depreciation over time.

The straight-line method is often used for assets with a long useful life, such as buildings and equipment.

In contrast, the declining balance method is used for assets with a shorter useful life, such as computers and software.

The declining balance method allows businesses to accelerate depreciation in the early years of an asset's life.

Depreciation is an important consideration for businesses that purchase used equipment, as it can impact their financial statements and tax obligations.

Additional reading: How Do I Depreciate Equipment

Choosing a Depreciation Method can be a bit overwhelming, but don't worry, I've got you covered. First, consider the type of machinery you're buying - if it has a predictable useful life, the straight-line or declining digits method might be a good choice.

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For machinery with an uncertain useful life, the declining balance method is a better option. If the machinery has a high residual value, either the straight-line or declining balance method will work.

On the other hand, if the machinery has a low residual value, the declining digits method is the way to go. And if you're a conservative accountant, you can't go wrong with the straight-line or declining digits method.

Tax implications are also an important factor to consider, so be sure to consult a tax advisor to choose the most suitable method. Remember, depreciation reduces the asset's value on the balance sheet and is recorded as an expense in the income statement, which affects your company's net profit.

Here are the four commonly used depreciation calculations:

Each of these methods has its own formula, but they all aim to help you accurately calculate the depreciation of your used equipment.

The Section 179 Deduction is a tax benefit that allows businesses to deduct the full purchase price of qualifying equipment and software. This deduction is available for both new and used equipment.

The deduction is not limited to new equipment, you can also depreciate used equipment. In fact, most tangible goods used by American businesses, including software and business-use vehicles, qualify for the Section 179 Deduction.

The Section 179 Deduction has a cap of $2.5 million in expenditures for the year 2018, after which the deduction begins to phase out dollar-for-dollar. This cap is an important consideration when deciding whether to use the Section 179 Deduction.

If you exceed the cap, you can still deduct a portion of the purchase price using bonus depreciation, which does not have a cap. This is a great benefit for businesses that need to acquire new or used equipment.

The 100 percent bonus depreciation is scheduled to start phasing out on January 1, 2023, so it's a good idea to take advantage of it while it's still available.

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You can calculate the depreciation of used equipment using various methods, including straight-line, declining balance, units of production, and sum-of-the-years'-digits.

Straight-line depreciation is the simplest method, allocating an equal amount of the equipment's cost to each year of its useful life. This formula is asset cost minus salvage value, divided by its useful life.

The declining balance method allocates a larger portion of the cost in the earlier years of the equipment's life and a smaller portion to later years.

Units of production depreciation allocates the cost of the equipment based on how much it is used, making it suitable for small businesses that want to take more depreciation in years when they use the asset more often.

The sum-of-the-years'-digits method allocates more of the cost to the earlier years, but not as much as the declining balance method.

Here's a quick comparison of the four methods:

Depreciation is a tax-deductible expense that can help offset the cost of used equipment.

The IRS allows businesses to depreciate used equipment over its useful life, which is typically 5-7 years for most equipment.

As a business owner, it's essential to understand the tax implications of depreciating used equipment to maximize your savings.

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You might be surprised at how quickly a piece of equipment can depreciate in value, and what that means for your taxes. Imagine you bought a bulldozer for $100,000 and it depreciated by $20,000 per year over five years.

Losing depreciation can lead to a higher tax bill than expected. After three years, you'd have already deducted $60,000 in depreciation, but you'd still have $40,000 left to claim for the remaining two years of its useful life.

Selling the bulldozer too early means forfeiting that additional $40,000 in depreciation deductions. This can increase your taxable income, pushing you to a higher tax bracket and resulting in a significantly higher tax bill.

You might think you've broken even on the sale, but the loss of depreciation deductions can still cost you. It's as if you've suddenly earned an additional $40,000 for that tax year, even though you may have only sold the equipment for its fair market value of $40,000.

Selling business equipment for more than its current market value is considered a profit, or a gain, and is taxed by the IRS under the capital gain rules.

This type of situation usually arises when a buyer is willing to pay more than the equipment is worth due to high demand or scarcity.

The IRS applies the capital gain taxes depending on how long you've owned the equipment. If you've owned it for one year or less, the gain is treated as a short-term capital gain, taxed at your regular income tax rates.

If you've owned the equipment for more than a year, it's considered a long-term capital gain, taxed at a lower rate. Long-term capital gains are taxed at 0%, 15%, or 20%, depending on your income tax bracket.

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Recovering investments is crucial for businesses, especially when it comes to machinery. The business needs to recover the money it has invested in the machinery to be able to keep on operating.

Depreciation matters more with second-hand machinery, which tends to have more wear and tear, even if it can be used for several more years. This means the business will have to write down the value of the machinery over a shorter period of time.

New machinery, on the other hand, can be written down over longer periods. This gives businesses more time to recover their investments, but it also means they'll have to pay taxes on the depreciation over a longer period.

However, buying used machinery has its benefits, and one of them is that it allows businesses to recover their investments faster.

You can sell your used equipment for less than its adjusted price without owing taxes on the sale. If you're lucky, you might even be able to claim a capital loss, which could reduce your overall tax liability for the year.

You must still report the sale of any business asset to the IRS, regardless of whether you've profited or not.

The new tax law is a game-changer for contractors, especially when it comes to purchasing equipment.

You can deduct the full cost of your equipment purchase in the first year, giving you an immediate tax benefit. This is because a dollar today is worth more than a dollar in the future due to potential earnings and inflation.

The finance concept of "net present value" explains why taking a write-off in the first year is more beneficial than spreading depreciation over time.

You don't typically use tax benefits as a reason to buy equipment, but if your business needs it for sound business purposes, it's a good time to take advantage of these tax benefits.

The deductions also hold true for financing used equipment, which could enable the deduction to exceed your loan payments in the first year, allowing you to get the deduction up front for tax purposes.