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Are income taxes affected by accelerated depreciation?

Author:
Harold Averkamp, CPA, MBA

Definition of Accelerated Depreciation

Accelerated depreciation means the cost of an asset used in a business will be charged to Depreciation Expense at a faster rate than straight-line depreciation. However, the total amount of depreciation expense over the life of the asset cannot exceed the asset’s cost regardless of the depreciation method. In other words, the difference between accelerated depreciation and straight-line depreciation is a “timing difference.”

In the U.S., a business is allowed to use straight-line depreciation on its financial statements and at the same time use accelerated depreciation on its income tax returns.

Using accelerated depreciation on its U.S. income tax returns will mean greater depreciation expense and smaller taxable income in the earlier years of an asset’s life. However, it will be followed by smaller depreciation expense and greater taxable income in the later years of the asset’s life. Therefore, a corporation with consistent taxable income will be able to defer some income taxes until the later years of the asset’s life. This is especially attractive because of the time value of money.

Example of Accelerated Depreciation

Assume a corporation acquires equipment with a cost of $600,000 that will be used in its business for 10 years (120 months) and have no salvage value at the end of 10 years. On its monthly financial statements, the corporation will likely report Depreciation Expense of $5,000 for 120 months. However, on its U.S. income tax return, the corporation is allowed to depreciate the asset over 7 years at an accelerated rate. Often the income tax regulations (See IRS.gov) allow special depreciation in which the equipment will be expensed sooner or even immediately. This could result in a significant reduction in the amount of income taxes to be paid in the early years of an asset’s life, which in turn reduces the time required for the corporation to recover the amount it paid for the equipment.

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About the Author

Harold Averkamp

For the past 52 years, Harold Averkamp (CPA, MBA) has
worked as an accounting supervisor, manager, consultant, university instructor, and innovator in teaching accounting online. He is the sole author of all the materials on AccountingCoach.com.

Learn More About Harold

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