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Depreciable life is a reflection of the number of years an asset is likely to be in use. For each year of depreciable life, a percentage of the asset's initial value can be treated as an accounting expense on taxes. The accounting expense reduces total income for tax purposes, reducing tax liability. Calculating depreciable life allows people to spread the cost of an asset out over several years instead of claiming all of the tax benefits in a single year.
Tax agencies usually publish tables of allowable depreciable life for common assets. For example, appliances usually have a depreciable life of five years. A building might have a depreciable life of 25 years. Specific capital improvements that make a building more functional for a business can have depreciable lives of varying lengths, depending on the nature of the improvements.
In a simple example of how depreciable life works, a business could buy a van for deliveries, expecting to use it for five years. In straight line depreciation, the business would divide the value of the van by five. Each year, a fifth of the truck's price could be recorded as an accounting expense on taxes. Spreading the value of the truck over five years of taxes allows the business to reduce its taxable income to receive tax benefits every year.
There are other approaches to depreciation. Some accountants deduct more of the value of an asset in the early years of its depreciable life. This allows for larger tax benefits at first. When an asset is especially expensive, this may be beneficial because it allows the company to recoup more of the costs of the asset right away. Depreciation frees up cash flow for a business by reducing overall tax liability, allowing it to use those funds for further improvements or expansion. It is important to note that when assets are used for personal and business use, only the business use is counted for depreciation.
The depreciable life of assets is a reflection of how long such assets are likely to be used, but the assets can be used beyond the depreciation point if they are still useful to the business. Likewise, some assets may need to be replaced before the end of their supposedly useful life. Computer equipment is an excellent example. Tax authorities may state that electronics have a depreciable life of five years, but a business might need to replace computers on a more regular basis, such as every two years.
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