Before we dive into the three types of depreciation, let’s do a brief summary of what depreciation is.

Depreciation is an accounting method that is used to allocate a cost to an item or asset as it ages through its useful life. Instead of claiming a single asset write off deduction, a deduction estimates how much of a tangible item has been used up.

Depreciation makes it possible for businesses to earn money from a tangible asset – such as a truck – whilst claiming the cost of that asset over time. Depreciation helps a company or owner reduce the amount of taxes they are paying at the end of the year.

There are three main types of depreciation:

- Straight-line depreciation
- Declining balance depreciation and
- Double declining

**Let’s start by going over Straight-Line Depreciation, the most basic form of depreciation. **

This is when equal parts of an asset are depreciated each year. Here’s an example:

If an appliance worth $10,000 is purchased and has a salvage value (or residual value) of $2,000, then the appliance has an $8,000 depreciable current book value. If we assume that the useful lifespan of the appliance is 8 years, using straight-line depreciation then $1,000 is the annual depreciation value for the asset.

**The second form of depreciation is Declining Balance Depreciation. A declining balance depreciation method is a little more complex. **

This is an accelerated form of depreciation which depreciates a piece of property at its straight-line depreciation percentage times its remaining depreciable amount each year

Declining Balance Depreciation = Current Book Value × Depreciation Rate

Let’s apply that to our previous example.

Year 1, with a current book value of $8,000, the depreciation rate is 12.5%. So, the amount claimed that year is $8,000 times 12.5% or $1,000.

Year 2, the current book value is now $7,000. When multiplied by 12.5% again the claimed amount for that year is $875

Year 3, our depreciable amount is only going to be $765.63

The amount gets smaller and smaller with each passing year.

**The last form of depreciation is Double Declining Balance or DDB**

This is another accelerated form of depreciation. This accounting method depreciates assets twice as quickly as the declining balance method.

The formula for DDB is

Depreciation=2 × Straight Line Depreciation Percent × Book Value at the beginning of the period

Okay let’s apply that to our same example.

The Straight-Line Depreciation Percent is 12.5% over the 8 years.

In year 1, the current book value is $8,000.

So, in year 1 we have 2 times 12.5% times $8,000 which equals $2,000.

In year 2, our book value is now $6,000, so our depreciation amount is $1,500

In year 3, with a book value now being $4,500, our depreciation amount is now only $1,125.

Depreciation is used for fixtures, fittings, and improvements to a piece of real property, however the land itself cannot be depreciated. It becomes most important for tax savings when an asset is being held as an investment property.

Take a look at one of our free real estate practice exams for a bit of practice before exam day!

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