Depreciation is one of the standards of tax preparation that every tax professional must have a firm grip on to do right by their client. In order to understand depreciation you must first understand basis. Over the next several posts in this series we will review basis and depreciation, discuss the relationships of them to each other, and review old, new and expiring depreciation provisions.
Basis is generally defined as the taxpayer’s investment in the asset and depreciation is defined as the allocation of an asset’s cost over a period of time that is in line with the useful life of the asset. This allows the recovery of normal wear and tear on an asset throughout it’s useful life.
In order to understand depreciation correctly, there are several things you must have a solid grounding in first. Three things must be established before anything can be determined about the depreciation of an asset:
1. Type of property/asset
2. Use of the property/asset
3. Basis in the property/asset
The terms “property” and “asset” will be used interchangeably throughout this text.
Type of Property
There are two types of property; real and personal. Real property (real estate) includes land, buildings, and their structural components. All property that is not real property is personal property. Personal property is broken down further and categorized as either tangible or intangible property.
Tangible property has a physical existence and an intrinsic value or a value in and of itself. Things you can put your hands on are tangible property, like, livestock, machinery, vehicles, furniture, or even the book you are now reading.
Intangible property has no intrinsic value in and of itself, rather, the value comes from the property it represents. An example is a stock certificate. The piece of paper it is printed on is basically worthless by itself, however, the certificate gives you the right to a certain number of shares of stock that may be very valuable. Other examples of intangible property are currency, copyrights and patents, goodwill, and insurance.
Tomorrow, uses of assets.
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