How does per-annum depreciation for taxes work after the first year of depreciation?

Question

My state requires me to report personal property that I use for my design business. Here is the specific form in question: http://www.dat.state.md.us/sdatweb/pp1inst_2015.pdf. The form says that data processing equipment, such as computers, needs to be depreciated at 30% per annum.

The first time I filed this form, in 2013, I reported the computer's cost at its full value with no depreciation. To use round numbers, let's say that the computer was worth $1000 at the time. (It was actually more than that.)

The second time, in 2014, I reported the computer's original cost (hypothetically $1000) and had to report 30% depreciation on it. Using $1000 as the original cost, the depreciation would have been $300, and the computer's current end-of-year value for 2013 (used in the balance sheet's "Net Property, Plant and Equipment" line) would have been $700. (For simplicity, let's assume the computer and its depreciation are the only things I have to report in that section of the balance sheet. Here are my state's balance sheet and depreciation schedule forms.)

This year (2015, for tax year 2014) is the third year I have had to file this form and the second year that I have had to report the computer's depreciation. I'm assuming that I'm adding the second year's depreciation to the first year's. So the total depreciation of the computer in our scenario would be .30*1000 + X, where X is the depreciation during the second year of depreciation. The computer's total value now would be (1000 - .30*1000 - X) = Y.

If the second year's depreciation is calculated based on the original value of the computer, I get: total depreciation = (.30*$1000) + (.30*$1000) = $300 + $300 = $600. The total value of the computer now would be $1000 - $300 - $300 = $400.

If the second year's depreciation is calculated based on what the computer was worth at the beginning of the year (i.e. after the first year of depreciation), I would get: total depreciation = (.30*$1000) + (.30*($1000-$300)) = $300 + (.30*$700) = $300 + $210 = $510. Then the total value of the computer now would be $1000 - $510 = $490.

Since the personal property return's instructions say that property will normally not be depreciated below 25% of the cost, I think the second formula is correct, but I wanted to check.

Which is correct? Or is a different formula correct?

Answer 1

The first method is the correct one.

You bought an asset worth of $1000 and you put it on your depreciation schedule. What it means is that you get to write off the $1000 over a certain period of time (and not at once, as you do with expenses).

But the value you're writing off is the $1000 regardless of how much you've written off already.

Assume you depreciate in straight line over 5 years (that's how you depreciate computers for Federal tax purposes, most states follow). For the simplicity of the calculation, assume you depreciate each year as a whole year (no mid-year/mid-quarter conventions). The calculation is like this:

Year  |  Original Basis  | Adj. Basis EOY  | Depreciation this year | Accumulated Depr.
  1   |  $1000           | $800            | $200                   | $200
  2   |  $1000           | $600            | $200                   | $400
  3   |  $1000           | $400            | $200                   | $600
  4   |  $1000           | $200            | $200                   | $800
  5   |  $1000           | $0              | $200                   | $1000
  6   |  $1000           | $0              | $0                     | $1000

If you sell the computer - the proceeds above the adjusted basis amount are taxed as depreciation recapture up to the accumulated depreciation amount, and as capital gains above that.

So in your case - book value is the adjusted basis at the end of the year (EOY), depreciation this year is the amount you depreciate in the year in question out of the total of the original cost, and the accumulated depreciation is the total depreciation including the current year.

In Maryland they do not allow depreciating to $0, but rather down to 25% of the original cost, so if you bought a $1000 computer - you depreciate until your adjusted basis is $250. Depreciation rates are described here (page 5). For computers (except for large mainframes) you get 30% depreciation, with the last year probably a bit less due to the $250 adjusted basis limitation.