One of the main reasons why financial experts advise against over-investing in your business early on is due to a phenomenon known as depreciation. This is a natural process in which an asset loses value over the course of time, either due to the fact that it diminishes in efficiency, naturally degrades or due to the fact that the newer versions of the same product (mostly when it comes to electronics) are lowering its market value.
This means that a $1.000 you use to purchase an asset; it may be worth somewhat less in just a couple of months. In order to avoid this from becoming a serious problem, you need to learn how to spread the cost of your business assets and here are several tips that can help you out.
Understanding the depreciation
In order to be somewhat proficient at spreading your assets, you first need to understand what the depreciation actually is. First of all, depreciation is a phenomenon that (in a general sense) applies to every single purchase that you make, however, from the perspective of tax, it needs to fulfill three major criterions. First, it has to cost more than $500. Second, it has to have a life expectancy of over a year. These two criterions alone make it more than clear that supplies in no way qualify for tax depreciation. Finally, the asset needs to be owned by your business, which means that the rental property and rented equipment don’t qualify either.
Naturally, there are certain assets that don’t depreciate over the course of time. We’re talking about the property and trading stocks, as well as any other asset that doesn’t fulfill all of the above-listed three requirements. One more thing worth keeping in mind is the fact that the assets that are a subject to some other tax provision, meaning that their cost is already reduced, also don’t fall under this category.
Making an independent estimate
In order to make an independent estimate of your depreciation rate, you need to know three things – the value of an asset, the depreciation method (which may vary) and the tax depreciation rate (which depends on the local laws and regulations). The value of the asset is easy to know, seeing as how you’re the one who made the initial purchase, however, what gets most people confused is the ratio of the value after the first deduction. You see, when looking at the value, in most scenarios, you’re only looking at the initial value which is fixed. After the first deduction, as well as each subsequent one, the value that is left goes under the term of adjusted tax value.
As for the depreciation method, this is where a lot of people get confused, even though the situation is as simple as it gets. You either have the diminishing value, which resets the total value of your asset each year, thus deducting from the adjusted tax value. This means that the deduction itself is somewhat smaller each year. Aside from this, you also have a straight value depreciation method, which depreciates by the same amount each year. This is the scenario we’ve mentioned above. Keep in mind that you’re not restricted to a single method for all the assets you own but that you do have to use the same method per each asset in the same year.
Finally, we come to the tax depreciation rate, which is somewhat harder to calculate. It relies on the usefulness of the asset over the course of time – the useful life of an asset. Even though neither of these is impossible for you to calculate on your own, it would definitely be wiser to outsource tax depreciation to a specialized agency. This is particularly true in a situation where you need some professional surveying.
Which assets are fixed?
Another thing you need to understand is the term fixed asset. This is an asset that is purchased in order to be used in your production process, making them incredibly important for your day-to-day operations. However, these assets are not necessarily machines or pieces of equipment. Professional fees, periodic replacements, freighting and handling, import duties, site preparation and even the installation and assembly of a newly purchased item can be considered as fixed assets.
Previously, we talked about the useful life of an asset, so, it might be a good idea to try and further clarify the term. The useful life is a time-period after which the item you’ve purchased no longer has any value. Normally, they could be expensed if this happens in a single year, however, keep in mind that the time matters more than calendar years. What we mean by this is the fact that calculating November to January as a full year isn’t a smart, ethical nor legal practice. Therefore, it is to be avoided at all costs.
Keeping all records
At the end of the day, it’s incredibly important that you keep all the records regarding your depreciation, as well as anything else tax-related for as long as you can. The minimal advised time of keeping these records is about seven years, however, in the digital world, where you’re not compelled to worry about the physical storage space that this takes, you can feel free to keep these records indefinitely. Think about it, the benefit of this goes beyond your own legal protection. Should the need arise, you can use these records for data harvesting, in order to analyze them and make a fiscal projection for the future.
Finally, in order to be a successful entrepreneur you need to accept the fact that things change over the course of time and depreciation is just one of its many aspects. In fact, those who think that their work of forming a business structure is something that could sometimes end up making the most rigid of structures. Instead, you need to focus on flexibility, adaptability, and scalability. The first step you should make on this journey of a thousand miles lies in learning how to spread the cost of your business assets.