IRS Schedule C, Profit or Loss From Business, is the form sole proprietors use to report business income and expenses. One of the form's listed expenses is depreciation, an annual deduction that lets you recover the cost of a tangible business asset.
To understand how to calculate depreciation tax deductions, use Form 4562 Depreciation and Amortization, and enter the result on Schedule C. Form 4562 accommodates the three depreciation types you can use: Section 179 depreciation; special depreciation allowance; and MACRS (Modified Accelerated Cost Recovery System).
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Understand Some Basic Concepts
Form 4562 references a few fundamental terms you must understand before attempting to calculate depreciation, including:
- Listed property: Depreciable property you use primarily, but not exclusively, for business. Also called mixed-use property, it is subject to special depreciation rules based upon percentage of business use. Part V of Form 4562 is where you report listed property and prorate depreciation based upon business-use percentage.
- Recovery period: This is the number of years you depreciate an asset. The IRS provides detailed tables that assign recovery periods to different assets under MACRS.
- Depreciation Method: You can use the straight-line method to depreciate assets in equal annual amounts or choose an accelerated method to front-load your depreciation deductions.
- Amortization: A process similar to depreciation that applies to intangible assets, such as patents.
Read More: How to Calculate Depreciation Types and Percentage
Calculate Section 179 Depreciation
Section 179 allows you to immediately deduct the total cost of certain assets put into service during the year. Form 4562 Part I shows how to calculate depreciation on computer software, equipment, vehicles and other Section 179 property. You must first complete Part V if you intend to claim the Section 179 deduction for listed property.
Limits apply to the value of property eligible for this deduction, and the limits change annually due to adjustments for inflation. You can use Worksheet 1 in the instructions for Form 4562 to calculate your maximum Section 179 limitation.
Calculate the Special Depreciation Allowance
The special depreciation allowance (Part II of Form 4562) lets you expense a percentage of the price of certain qualified property put into service during the current year. For 2022, you can immediately deduct 100 percent of the property's depreciable cost, but the percentage declines in subsequent years. Qualified property includes:
- Tangible property with a MACRS recovery period of 20 years or less.
- Computer software.
- Water utility property.
- Qualified television, film and theatrical productions.
- Qualified reuse and recycling property.
No asset price maximums limit your special depreciation allowance, which is an additional deduction you can use after any Section 179 expense deduction, but before MACRS.
Calculate MACRS Depreciation
Part III Section B of Form 4562 contains a worksheet to calculate the depreciation deductions for properties with multi-year recovery periods (from three years to 39 years) that you put into service during the current year, excluding listed property. Calculate the current year's depreciation deduction using the following data items for each class of property:
- Recovery period classification.
- Month and year placed into service.
- Basis, or cost, for depreciation.
- Recovery period.
- Convention, such as the number of months within a partial year for which you claim depreciation.
- Method, such as straight-line, the sum of digits and double declining.
You may need to use the Alternative Depreciation System (ADS) instead of MACRS for certain assets, such as foreign property. Use Part III Section C to calculate the ADS deduction for the year.
When depreciating business vehicles, you must also complete Part V Section B, which serves as a manual IRS car depreciation calculator.
Complete the Process
After computing your current year's depreciation deductions, total them in Part IV of Form 4562 and copy the number to the Schedule C line for depreciation. After figuring your total profit or loss on Schedule C, transfer the amount to your Form 1040 tax return and Schedule SE, Self-Employment Tax.