Depreciation is the accounting method that spreads a tangible asset's cost over its useful life, reducing taxable income each year without an actual cash outlay. It applies to physical business property (equipment, vehicles, buildings) and is distinct from amortization, which applies to intangible assets and loan principal.
Depreciation allocates the cost of a fixed asset over the years it's actually used, rather than deducting the full purchase price the year it's bought. Each year's depreciation deduction reduces both taxable income and the asset's book value on the balance sheet (cost minus accumulated depreciation) — which is why book value and the asset's real resale value can diverge significantly over time. Depreciation only applies to tangible assets with a useful life beyond one year; land itself is never depreciated because it isn't considered to wear out. The IRS requires MACRS depreciation (Modified Accelerated Cost Recovery System) for most tangible business property placed in service after 1986, assigning assets to recovery-period classes — 5-year for computers and vehicles, 7-year for office furniture and most machinery, 15-year for land improvements, 39-year for non-residential real estate — and front-loading larger deductions in the early years compared to straight-line depreciation (an equal deduction every year of the asset's useful life). Two acceleration tools sit inside otherwise-MACRS-eligible purchases. Section 179 lets a business deduct the full purchase price of qualifying equipment or software in the year of purchase, up to $1,160,000 in 2024, subject to an income limitation and a spending-cap phase-out. Bonus depreciation is a separate accelerated first-year deduction that the Tax Cuts and Jobs Act set at 100% through 2022 and is now phasing down — 60% in 2024, 40% in 2025, 20% in 2026, 0% starting 2027 absent a Congressional extension — with no income limitation, meaning it can create or deepen a net operating loss the way Section 179 cannot. Depreciation matters directly for business-loan underwriting because it's a non-cash charge: a lender evaluating DSCR typically adds depreciation back to net income to estimate the actual cash flow available to service debt, so a business showing modest net income after heavy depreciation deductions can still qualify on a cash-flow basis. This add-back is most consequential for equipment-heavy borrowers and businesses financed through a commercial real estate loan, where depreciation deductions run largest.
Depreciation applies to tangible assets — equipment, vehicles, buildings. Amortization applies to intangible assets (patents, goodwill, loan origination costs) and to paying down loan principal over time. Both spread a cost over a useful life or loan term, but they apply to different asset types.
MACRS (Modified Accelerated Cost Recovery System) is the IRS-required depreciation method for most business property placed in service after 1986. It assigns assets to recovery-period classes (5-year for vehicles and computers, 7-year for most machinery and furniture, 39-year for non-residential real estate) and front-loads larger deductions in the early years compared to straight-line depreciation.
Section 179 lets a business deduct the full cost of qualifying equipment immediately, up to $1,160,000 in 2024, but is limited by taxable income and phases out above a spending cap. Bonus depreciation has no income limitation and can create or deepen a net operating loss, but in 2024 it only covers 60% of the cost immediately (phasing down from 100% in 2022 toward 0% in 2027) with the remainder following the normal MACRS schedule.
Depreciation is a non-cash expense — it reduces taxable income without an actual cash outlay. Lenders calculating debt-service coverage (DSCR) typically add depreciation back to net income to estimate the real cash flow available to make loan payments, so heavy depreciation deductions don't automatically hurt loan eligibility the way they reduce reported profit.
Not necessarily. Depreciation reduces the asset's book value on the balance sheet (cost minus accumulated depreciation) for accounting and tax purposes, but the asset's actual market or resale value depends on real-world condition and demand — the two figures often diverge significantly, especially for real estate, which can appreciate in market value even as its book value depreciates.