e rate at which you are allowed to depreciate a given item. Why should Uncle Sam care? Because whenever you depreciate an asset, your write-off of its value goes to your income statement as an expense, which reduces your income and therefore reduces your tax burden. Thus, it is in your interest to depreciate as fast as possible, while itRecently, a client asked me "So what exactly is depreciation?" I suspect that depreciation is a concept poorly understood by many non-accountants. As a non-accountant myself, I had only the vaguest understanding of depreciation until one night during business school when, finally, I saw the light. I'd like to present here a nutshell depreciation. The concepts are the same regardless of the type of asset in question, but here we'll focus on real estate...

Generally speaking, an old asset is worth less than a new asset. Why? Because things wear out. As an example, I'll use my very first car, a 'hip' Plymouth Volare handed down to me from my grandfather. When the Volare was a brand new car, it was worth 100% of its purchase price. By the time I got it many thousands of miles later, it was worth somewhat less than that. And then by the time I had passed it off to my brother, who passed it off to a cousin, who abandoned it somewhere in the swamps of New Jersey... well, it wasn't worth much at all by that point.

In accounting, when an asset is first purchased, it is placed on the balance sheet at its full purchase price. 'Depreciation' is the means by which you continually adjust the value of the asset downwards, so that the asset's book value more closely reflects reality. Uncle Sam is glad to lend a helping hand, by decreeing the rate at which you are allowed to depreciate a given item. Why should Uncle Sam care? Because whenever you depreciate an asset, your write-off of its value goes to your income statement as an expense, which reduces your income and therefore reduces your tax burden. Thus, it is in your interest to depreciate as fast as possible, while it

eciation. The concepts are the same regardless of the type of asset in question, but here we'll focus on real estate...

Generally speaking, an old asset is worth less than a new asset. Why? Because things wear out. As an example, I'll use my very first car, a 'hip' Plymouth Volare handed down to me from my grandfather. When the Volare was a brand new car, it was worth 100% of its purchase price. By the time I got it many thousands of miles later, it was worth somewhat less than that. And then by the time I had passed it off to my brother, who passed it off to a cousin, who abandoned it somewhere in the swamps of New Jersey... well, it wasn't worth much at all by that point.

In accounting, when an asset is first purchased, it is placed on the balance sheet at its full purchase price. 'Depreciation' is the means by which you continually adjust the value of the asset downwards, so that the asset's book value more closely reflects reality. Uncle Sam is glad to lend a helping hand, by decreeing the rate at which you are allowed to depreciate a given item. Why should Uncle Sam care? Because whenever you depreciate an asset, your write-off of its value goes to your income statement as an expense, which reduces your income and therefore reduces your tax burden. Thus, it is in your interest to depreciate as fast as possible, while it

re was a brand new car, it was worth 100% of its purchase price. By the time I got it many thousands of miles later, it was worth somewhat less than that. And then by the time I had passed it off to my brother, who passed it off to a cousin, who abandoned it somewhere in the swamps of New Jersey... well, it wasn't worth much at all by that point.

In accounting, when an asset is first purchased, it is placed on the balance sheet at its full purchase price. 'Depreciation' is the means by which you continually adjust the value of the asset downwards, so that the asset's book value more closely reflects reality. Uncle Sam is glad to lend a helping hand, by decreeing the rate at which you are allowed to depreciate a given item. Why should Uncle Sam care? Because whenever you depreciate an asset, your write-off of its value goes to your income statement as an expense, which reduces your income and therefore reduces your tax burden. Thus, it is in your interest to depreciate as fast as possible, while it

at point.

In accounting, when an asset is first purchased, it is placed on the balance sheet at its full purchase price. 'Depreciation' is the means by which you continually adjust the value of the asset downwards, so that the asset's book value more closely reflects reality. Uncle Sam is glad to lend a helping hand, by decreeing the rate at which you are allowed to depreciate a given item. Why should Uncle Sam care? Because whenever you depreciate an asset, your write-off of its value goes to your income statement as an expense, which reduces your income and therefore reduces your tax burden. Thus, it is in your interest to depreciate as fast as possible, while it

e rate at which you are allowed to depreciate a given item. Why should Uncle Sam care? Because whenever you depreciate an asset, your write-off of its value goes to your income statement as an expense, which reduces your income and therefore reduces your tax burden. Thus, it is in your interest to depreciate as fast as possible, while it is in the IRS' interest to make you depreciate as slow as possible.

It's important to remember that depreciation is entirely a 'paper' rather than a 'real' transaction. No cash ever changes hands. For this reason, depreciation can't affect cash flow. That's why when you look at a cash flow statement, you'll see that depreciation is added back to net income (depreciation was deducted from revenue on the income statement, so it needs to be added back on the cash flow statement).

In the case of real estate, it gets a little more complicated. When you buy a building, you are typically buying both the building as well as the land it sits on. Buildings wear out, but land doesn't. As a result, you can only depreciate the portion of the purchase price which can be attributed to the building. Where are you supposed to get that number?... the property's appraisal, where the building/property split will be included.

Once you know the building value, you can apply the IRS' building depreciation schedule. Unfortunately, the property won't be depreciated and will sit on your books at full value until you sell.

I hope this gets you started on a better understanding of depreciation!