So, what is Depreciation?
- A reduction in the value of an asset with the passage of time, due in particular to wear and tear.
- Decrease in the value of a currency relative to other currencies.
Depreciation is the annual deduction to recover the cost of doing business or wear and tear on income-producing property (equipment, vehicles, etc) with a useful life of more than one year. Property is depreciated by a certain percentage amount each year determined by the us of various formulas; from the time it is put in service by the company until either the property is taken out of service, all the depreciable costs are deducted, or the property in your business is no longer in use or for the production of income.
Property can be depreciated if it meets the following requirements:
- It has a determinable useful life.
- It wears out, decays, gets used up, becomes obsolete or loses value from natural causes.
- It is either used in a business or held for the production of income.
Who can Depreciate property?
The owners of any property that they own or are leasing-to-own that use that property to earn income.
How long do you depreciate a Semi Truck?
Semi-Truck tractors and trailers must be depreciated for 5 years.
Side Note: I had some confusion on this issue early on, because a number of accountants had recommended the 3 year election on trucks and the 5 year on trailers while others recommended 5 years on both. I wanted to make sure I had my facts straight so I looked through the laws and instructions from the IRS and found that the confusion lies largely in the fact that a "Tractor" is a 3 year asset, while a "Truck" is a 5 year. The majority of drivers refer to their truck as a tractor-trailer, so in being told that the truck is a tractor, the accountants are classifying the trucks as tractors. Now, you could debate, that because of the language in the law, this a technicality, however, if the IRS comes knocking on your door, do you really want to debate the problems with the english language with them?
When do you need to start depreciating property?
Property (in this case a Semi Truck), needs to start being depreciated within the year that it is purchased. The time at which the property should start being depreciated depends largely on the time at which during the year it was placed in service in the company or in the contractors authority. As a result the IRS has come up with three lovely (and not making a lot of sense) categories. These are called "applicable conventions."
1) “Half-year convention,” All property (semi truck in this case) placed into service, or disposed of, during a taxable year was placed into service, or disposed of, at the midpoint of that year.
(§ 168(d)(4)(A)) Section 168(d)(1) states that all taxpayers should use the half-year convention unless a different convention is specifically required by § 168(d)(2) or § 168(d)(3).
2) “Mid-month convention,” assumes that all property placed into service, or disposed of, during any month was placed into service, or disposed of, at the midpoint of that month.
(§ 168(d)(4)(B)) Section 168(d)(2) tells a taxpayer when it is appropriate to use the mid-month convention.
3) “Mid-quarter convention,” assumes that all property placed into service, or disposed of, during any quarter of a taxable year was placed into service, or disposed of, at the midpoint of that quarter.
(§ 168(d)(4)(C)) Section 168(d)(3) tells a taxpayer when it is appropriate to use the mid-quarter convention.
Typically for a Semi Truck we want to try and use the Half-Year Convention.
After determining your applicable convention (half-year in this case), you will also need to choose your depreciation method.
As the owner of a Semi-Truck, which is a 5 year asset you will want to us the Straight Line method for depreciation. This is the easiest option for a person calculating it by themselves, other options have special requirements and extra complications that you will want to get professional advice on. It also, depreciates the same amount each year which makes for easy calculations. Here is the formula below:
Residual Value is what the truck will be worth at the end of the depreciation (Example 1 uses $0 in its calculation)
Useful Life of Asset is the how long the vehicle will be depreciated for.
What does a Depreciation look like?
Consider you are a taxpayer with a five-year property (semi truck) worth $50,000 when purchased. We want to calculate how much the truck will depreciate each year, for this we use the straight-line method formula above.
Annual Depreciation Expense = $50,000 - $0
$10,000, is the amount that the semi-truck will be depreciated each year.
Next, we want to take into account that we have selected (in this example) the half year convention, because the the property was put into service on July 1. As a result, for the first year we will only do a half deduction of $5,000 at the end of that year.
Year 1- $5,000, deducted December 31st
Year 2- $10,000 deduction taken. $5,000 deducted on June 30. $5,000 deducted on December 31.
Year 3- $10,000 deduction taken. $5,000 deducted on June 30. $5,000 deducted on December 31.
Year 4- $10,000 deduction taken. $5,000 deducted on June 30. $5,000 deducted on December 31.
Year 5- $10,000 deduction taken. $5,000 deducted on June 30. $5,000 deducted on December 31.
Year 6- $5,000 deduction taken on June 30.
What do you do with the depreciation having calculated it?
The depreciation numbers needs to be kept on file somewhere safe.
The deductions can be claimed as a part of the yearly taxes as a part of the cost of doing business - and there are a lot of special requirements regarding this.
The amount that the truck is worth at the end of each depreciation period helps keep track of what the vehicle is worth. This is very important in the event of a sale where this number will greatly affect the sale price, or in an event such as an accident or major repair which puts the truck permanently out of service (insurance anyone?).
What is the lease-to-own loophole?
This is not so much a loop hole as it is an easier option for depreciation.
The regular payments made on the semi-truck can be used as the amount that is deducted from it's over-all worth each depreciation period.
So that is my understanding of depreciation in regards to Semi-Trucks.
I would once again like to remind everyone I am not a professional accountant and would recommend that you at least consult with one before attempting any major calculations. This article is for your understanding only.