Land, personal property, stocks, bonds, art, coins, and property with a lifespan of less than one year, as dictated by the IRS, are classified as assets that cannot be depreciated.
For every enterprise, depreciating assets is essential for reducing taxable income. However, not all assets qualify for depreciation. Properties such as buildings, vehicles, and equipment, which are long-term assets that wear out or depreciate over time, are typically depreciable.
For business owners, knowing which assets cannot be depreciated is crucial to prevent errors in tax filings. Misstatements or inaccuracies in financial documents can lead to penalties, interest charges, or an IRS audit.
Thus, it is vital to understand the type of asset and how to accurately account for depreciation for effective tax and financial management.
Depreciation involves the allocation of an asset’s cost over its useful life. While all depreciable assets are considered fixed assets, not all fixed assets are eligible for depreciation. To be depreciable, an asset must inherently lose value over time.
Assets that are not depreciated include those that are not owned by the business, do not generate income, or have a useful life of less than one year.
Why Can Certain Assets Not Be Depreciated in Accounting?
According to IRS Publication 704 on Depreciation, certain conditions disqualify an asset from being depreciated. These include:
- Personal Property: Assets like personal residences or private vehicles, used for non-business purposes, are not eligible for depreciation.
- Retirement from Service: Assets no longer used in business operations, whether through disposal, sale, or destruction, cannot be depreciated further, even if their cost hasn’t been fully recovered.
- Short Useful Life: Assets with a useful life of less than a year do not qualify as depreciable.
Types of Assets That Cannot Be Depreciated
Certain types of property are inherently non-depreciable according to IRS guidelines, including:
- Land Land does not depreciate as it does not wear out, diminish in value, or get consumed. The value of land typically appreciates over time, making it a non-depreciable asset, though costs associated with land preparation may be depreciated as they are considered separate improvements with determinable useful lives.
- Personal Property Property not used for business purposes, such as personal vehicles or homes, does not qualify for depreciation. Only business-use portions of mixed-use properties like vehicles are depreciable.
- Intangible Assets Assets such as goodwill, trademarks, and copyrights are not depreciated but are instead amortized over their useful lives.
- Inventory Items held for sale, such as merchandise in a store, are classified as inventory and are not depreciated since they are not used in business operations but sold to customers.
- Exempt Property Certain properties, including those used for less than a year or used in constructing capital improvements, do not qualify for depreciation. Costs associated with such properties are added to the basis of the improvements.
- Investments in Affiliated Companies Shares in other companies are not depreciated but may be subject to impairment if their value decreases.
- Stocks and Bonds Financial instruments like stocks and bonds, intended for sale, do not depreciate as they are not physical assets used in revenue-generating business activities.
- Antiques Unlike typical business assets, antiques can appreciate in value over time due to their age and rarity, thus they are not depreciated.
- Natural Resources Natural assets such as minerals or timber are subject to depletion rather than depreciation, accounting for their extraction and usage over time.
Criteria for Depreciable Assets To qualify as a depreciable asset, certain criteria established by the Internal Revenue Service (IRS) and Generally Accepted Accounting Principles (GAAP) must be met.
Essential Requirements:
- Ownership: The asset must be owned by the taxpayer, meaning the individual or business claiming depreciation must hold legal title to the asset.
- Business Use: The asset should be employed in business operations or income-producing activities. Assets used solely for personal purposes are not eligible for depreciation.
- Useful Life: There must be a determinable useful life for the asset, extending beyond one year, indicating it will provide economic benefits over several accounting periods.
- Value Reduction: Over time, the asset should depreciate in value due to wear and tear, obsolescence, or usage, which justifies the depreciation deduction.
Examples of Depreciable and Non-depreciable Property:
- A salon owner leases a building for ten years. Although the building itself cannot be depreciated because it is not owned, any leasehold improvements (such as installing custom sinks) are depreciable.
- A business owner acquires a plot of land for $100,000 to construct an office. The land’s cost is non-depreciable as land does not depreciate, but any enhancements like landscaping or fencing can be depreciated.
- A real estate agent buys a car for personal use, which cannot be depreciated unless it is later used for business, in which case depreciation can be claimed based on the percentage of business use.
- A coffee shop purchases an espresso machine and sells it within the year. Since the machine is disposed of in the same year it was bought, it cannot be depreciated. Instead, its cost is treated as an expense for that fiscal year.
Conclusion
It’s crucial for businesses to recognize the importance of precise tax filings, accurate depreciation calculations, and proper asset categorization in maintaining financial records. The IRS utilizes the Modified Accelerated Cost Recovery System (MACRS) for depreciating property placed in service post-1986. To claim depreciation under Section 179 for listed property, taxpayers must complete and submit Form 4562 with their tax returns for assets placed in service during the tax year.
