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What Is a Depreciation Tax Shield?

A depreciation tax shield aims to lower overall tax obligations by using depreciation on existing assets to claim tax deductions.
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  • Written By: Malcolm Tatum
  • Edited By: Bronwyn Harris
  • Last Modified Date: 06 April 2015
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A depreciation tax shield is a strategy that focuses on the ability to lower overall tax obligations by using depreciation on existing assets to claim tax deductions. The general approach for this type of activity requires identifying the amount of depreciation that is allowed for the tax period and multiplying that figure by the current tax rate. The resulting figure is considered to be the tax shield for that particular asset as related to the tax year in question.

The actual structure of a depreciation tax shield will depend greatly on what is and is not currently considered allowable in terms of the amount of the depreciation. In some nations, provisions within tax codes allow for what is known as accelerated depreciation. This is simply a situation in which the taxpayer is allowed to claim a larger amount of depreciation on an asset during the first few years of ownership, then claim incrementally less in later years. Other assets are not eligible for this type of depreciation, meaning the taxpayer can only claim up to a fixed amount in depreciation each tax year, based on the purchase price. In order to determine the amount of depreciation and be able to calculate the depreciation tax shield, identifying current policies on how to depreciate a specific type of asset is essential.

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One of the benefits of determining the depreciation tax shield is that it is possible to reduce the overall tax obligation for the period. This can be helpful for individuals, since this means more money that can be allocated to making new purchases, contributing more to a retirement fund, or acquiring additional assets that may be subject to depreciation the following year. Revenue agencies provide detailed information on how to determine if an asset is eligible for depreciation, and how the amount of depreciation can be determined. In like manner, tax professionals can assess the holdings of the client and identify how to make use of the depreciation tax shield approach to best advantage.

Since tax laws are subject to change from one year to the next, it is important to always secure current data when attempting to determine depreciation amounts and arrive at the depreciation tax shield associated with a given asset. Doing so helps to minimize the chances of possibly losing out on a deduction that would have lowered the tax obligation and made it possible to retain more income. For businesses and even for individuals with a significant amount of wealth, engaging the services of a professional to evaluate those assets can often lead to identifying additional deductions, easily offsetting any of the fees charged by that professional.

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