All about deprecation and getting your money’s worth

What is depreciation?

Whether you’re buying a home, car, or boat, the value of your assets will inevitably depreciate. Usage, wear and tear, and time can affect the value of an asset, making your item worth less than at the time of purchase. Depreciation is a loss of value in an item from the time of purchase. For example, imagine you’re seeking to purchase a new car. You arrive at the car dealership and find a sedan that catches your eye. You speak to a car dealer, finalize your purchase, and drive off the lot. As soon as you exit the dealership, the car is considered used. Subsequently, if you were to sell the car, it would be worth less than you purchased it for. This loss of value is referred to as depreciation.

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Causes of depreciation

There are a few causes of depreciation, which include the following:

• Wear and tear. An asset like a home or a car will naturally experience wear and tear. For example, properties naturally degrade over time. Hardwood floors will erode, lights will become discolored, pipes rust, etc. As an asset is used, its depreciation increases. When evaluating a home, or any used asset, make sure a thorough inspection is performed to confirm its condition is adequate. If you are purchasing a home, learn more first-home buying tips.
• Passage of time. Exposure to nature and the elements will depreciate the value of an asset. Wind, rain, and other weather conditions that are considered normal will gradually decrease its value.
• Obsolescence. When an asset becomes outdated—whether that’s caused by technological improvements, production, demand, etc.—its value also depreciates. Obsolescence is typically an issue for business owners, as they navigate changes to the product and industry they serve.
• Accident and abnormal factors. Abnormal conditions, extreme weather, and accidents can also cause your asset to depreciate. An earthquake, fire, or flood that affects the condition of your property will result in lost value.

Factors of depreciation

In addition to causes, there are factors that affect the rate of depreciation, and expected loss of value. Those factors include the following:

• Total cost. After adding both the purchase price and additional expenses associated with an asset, you have the total cost. Noting the total cost is important to calculate the eventual depreciation of the asset. For example, if you purchased a used car for $8,000 and had to buy a new radiator for $500, the total depreciation value would be $8,500.
• Estimated useful life. The lifespan of an asset helps determine how much it may depreciate over time, and no longer be useful. The more useful years an asset has, the slower the rate of depreciation. Used cars may have a shorter useful lifespan than new cars, so their rate of depreciation will be faster. If you are purchasing a car, learn whether you should by a used or new car.
• Estimated scrap value. The estimated scrap value is the amount of money you can get from an asset that is no longer usable. When calculating depreciation, you deduct this amount from the total cost of the asset.

What assets can depreciate?

Knowing what assets can depreciate is important for determining its true value for tax purposes. For business owners, depreciation provides tax benefits: depreciating assets can result in a reduction of taxable income to provide relief.

Assets that can depreciate include the following:

• Motor vehicles such as cars, boats, and motorcycles
• Property, both commercial and residential
• Electronic equipment such as computers

Assets that do not depreciate include land, collectibles, and investments.

Understanding depreciation can help you evaluate the total value of an asset you wish to purchase. Learn how to save for the purchases you want with our budgeting tips.