Straight-line depreciation is a standard methodology to calculate “wear and tear” costs over time.
This strategy implies an asset has no salvage value or depreciates by the same amount each year.
Straight-line depreciation is constant annually.
It Works How?
Use straight-line depreciation by estimating an asset’s economic life. Divide 1 by the predicted economic life in years.
This generates linear depreciation. Consider a five-year asset life: 1 ÷ 5 equals 0.2, or 20%. To calculate annual depreciation, multiply the asset’s original cost by the straight-line rate.
Assuming the asset costs $10,000, 1.20 x $10,000 = $1,200 per year.
This method helps you estimate annual depreciation at the start of the year and how it will influence net income or loss.
Why Choose This Method?
Because it needs less record-keeping and calculation, straight-line depreciation is simpler.
It calculates your annual tax obligation based on the asset’s cost, residual value, expected lifespan, and straight-line depreciation rate.
This strategy is best for equitably allocating an asset’s cost over its useful life without considering other considerations.
When to use this method?
This strategy is appropriate if you are unsure of how long an item will be used or anticipate it will be used sparingly (like a copier machine).
This strategy is also useful if an item will be sold at the end of its life and the cash profits utilized to buy a replacement.
You would apply straight-line depreciation while owning the asset and deduct this fraction of the total cost, then switch to MACRS when selling.
This strategy is also beneficial for assets intended for one person. This might be your car or a piece of company machinery operated by one person.
Why Not Use This Method?
Straightline depreciation ignores the fact that the frequency at which you use an asset like a car or truck is a substantial expense.
This means it will likely underestimate the expense of owning and using this asset. Straight-line depreciation does not accelerate tax savings because it is deducted equally each year.
This strategy is not suitable for assets that degrade faster than straight-line depreciation, such as computers that will become obsolete shortly.
Finally, this depreciation technique should not be employed when an asset has a shorter estimated economic life than its tax life, which is usually 7 years.
Other depreciation methods
The high-low approach simplifies double-declining balancing.
Another accelerated depreciation approach is best for assets that will be utilized intensively for several years before decreasing in use, such as a machine operated heavily in its first few years.
Declining Balance Method
Another double-declining balance-based accelerated depreciation approach is the declining balance method.
This method is better than straight-line depreciation for intensively utilized assets whose production capacity decreases with time, such as a machine that will become less productive after few years.
Method of Summing Years’ Digits
Accelerated depreciation methods like the sum-of-the-years’ digits method accommodate for an asset’s rising cost as it depreciates.
Modified Accelerated Cost Recovery System
MACRS replaced ACRS, which depreciates significant capital investments faster.
Modified Accelerated Cost Recovery System
The Modified Accelerated Cost Recovery System depreciates assets installed after 1986.
MACRS depreciation is the sole tax-allowed accelerated depreciation method and requires extra documentation.
It costs more since you must pay 1/2 of 1% of your asset base each quarter.
Method 150% Declining Balance
The accelerated 150% falling balance technique depreciates your deduction quicker than MACRS by using 1/2 of 1/3 of the entire basis as 1 year’s depreciation.
This is another accelerated depreciation approach that works with any method.
One last thought
Different depreciation methods should be employed depending on your item and its use.
No depreciation method is ideal, but each has pros and cons.
Depreciation schedules are difficult, so consult a tax professional if needed, however these approaches will help you calculate asset depreciation.
Straight-line depreciation is a handy approach for equally depreciating an asset at a given rate.
It basically calculates depreciation deductions in equal amounts for each asset unit over its useful life.
This strategy works when you know how long an asset will be in service and its salvage value.
The straight-line depreciation technique is not suitable for assets with a useful life of less than one year or for assets that will be used more intensively in the first few years and thereafter less so.
This strategy is likewise unsuitable for fluctuating salvage values.