Writing a depreciation policy for your business means putting in writing, before your accountants need to make judgment calls, how the company will capitalize assets, assign useful lives, pick a method for each asset class, handle the gap between book and tax depreciation, and document changes over time. A good policy is specific enough that two accountants would apply it the same way, and detailed enough to hold up in an audit.
The sections below walk through the decisions the document has to make, in the order you’ll draft them.
Define the Three Inputs Every Calculation Uses
Before the policy names a method, it has to define the numbers that feed every method. Getting these definitions right matters more than the method choice, because a loose estimate of useful life distorts your financials for every remaining year the asset sits on the books.
Historical cost is the total spent to acquire the asset and put it into service: purchase price, sales tax, shipping, installation, and site preparation. That figure becomes the depreciable basis on the balance sheet. Say so in the policy, so nobody expenses installation as a separate repair.
Estimated useful life is how long you expect productive use, measured in years or in output units like miles or units produced. The estimate has to account for wear, the pace of technological change in your industry, and any legal or contractual limits on how long you can use the asset.
Salvage value is what you expect to recover on disposal. Historical cost minus salvage value is the depreciable amount. A $50,000 machine with a $5,000 salvage value has $45,000 to spread across its life.
Assign a Method to Each Asset Class
The policy needs to specify a method for each class of assets, and the method should match how the asset actually delivers value. A building that gives roughly equal benefit each year calls for something different than a laptop that’s half obsolete after two years.
Straight-Line
Straight-line spreads the depreciable amount evenly across the useful life. It’s the default for financial reporting and the easiest to audit. Use it for buildings, office furniture, and other assets that deliver steady benefit over time.
Declining Balance
Declining balance methods front-load the expense. Double declining balance applies twice the straight-line rate against the asset’s remaining book value each year, and depreciation stops once book value reaches salvage value. Use it for technology equipment and anything else that loses capability fast.
Units of Production
Units of production ties depreciation to actual use. Divide the depreciable cost by expected lifetime output to get a per-unit rate, then multiply by actual production each period. It fits manufacturing equipment and vehicles where usage swings year to year.
Whichever method a class gets, state it in the policy and explain the reasoning. That explanation is what defends the choice to an auditor.
Set a Capitalization Threshold
The policy needs a dollar floor below which purchases are expensed immediately instead of capitalized. GAAP does not prescribe a specific number. The threshold exists for administrative convenience, and the only requirement is that expensing items below it doesn’t materially distort your statements.
On the tax side, the IRS de minimis safe harbor lets you deduct items costing up to $5,000 each if you have an applicable financial statement (audited financials or an SEC filing), or up to $2,500 each without one.1eCFR. 26 CFR 1.263(a)-1 – Capital Expenditures; In General Many companies align their book threshold with one of these tax figures to keep one set of records. Using the safe harbor requires a written accounting policy in place at the beginning of the tax year, so this is one of the sections of your document that has to exist by January 1.
Group Assets and Set Documentation Rules
Tracking every desk lamp as its own asset wastes time. Group similar assets into classes — computer hardware in one, production molds in another — and apply a single method and useful life to the entire class. List each group in the policy, along with its assigned life, method, and expected salvage value.
The document itself should list every asset class, the capitalization threshold, and the procedures for adding new assets and disposing of old ones. Assign someone to reconcile the fixed asset subledger to the general ledger at least quarterly; discrepancies compound quickly when nobody’s watching.
U.S. accounting standards also require you to disclose the depreciation methods and useful lives applied to major asset classes in the financial statement footnotes.2U.S. Securities and Exchange Commission. Supplementary Financial Information A well-documented internal policy makes those disclosures straightforward.
Address Tax Depreciation Alongside Book
Tax depreciation and book depreciation are separate calculations under different rules, and the policy has to speak to both. The differences generate deferred tax entries your accountants have to track, so the document should say which rules govern each side.
MACRS Classes and Methods
For tax purposes, the IRS requires most tangible property placed in service after 1986 to be depreciated under the Modified Accelerated Cost Recovery System.3Internal Revenue Service. Publication 946 – How To Depreciate Property MACRS replaces your useful-life estimates with prescribed recovery periods:
- 3-year property: certain manufacturing tools with a class life of four years or less
- 5-year property: computers, vehicles, and office machinery
- 7-year property: office furniture and most general-purpose equipment
- 15-year property: land improvements
- 27.5-year property: residential rental buildings
- 39-year property: nonresidential commercial buildings
MACRS uses 200% declining balance for 3-, 5-, 7-, and 10-year property, switching to straight-line when that produces a larger deduction. For 15- and 20-year property, the rate is 150% declining balance with the same switch. Real property uses straight-line over its full recovery period.4Office of the Law Revision Counsel. 26 USC 168 – Accelerated Cost Recovery System
Conventions
MACRS conventions standardize when depreciation starts and stops. The half-year convention is the default and treats every asset as placed in service at the year’s midpoint. The mid-quarter convention kicks in when more than 40% of the year’s property was placed in service in the last three months, and it treats each asset as placed in service at the midpoint of its acquisition quarter.5eCFR. 26 CFR 1.168(d)-1 – Applicable Conventions – Half-Year and Mid-Quarter Conventions The mid-month convention applies to real property.
The mid-quarter rule is the one that catches companies. A large December equipment purchase can retroactively change the convention for every asset placed in service that year, cutting first-year deductions across the board. Your policy should require someone to check the 40% test before year-end.
Bonus Depreciation and Section 179
Under the One Big, Beautiful Bill Act signed in 2025, qualified property acquired after January 19, 2025, is eligible for a permanent 100% first-year bonus depreciation deduction with no phase-down.6Internal Revenue Service. Treasury, IRS Issue Guidance on the Additional First Year Depreciation Deduction Amended as Part of the One Big Beautiful Bill Eligible property generally includes new and used tangible assets with a MACRS recovery period of 20 years or less. Full deduction in year one plus multi-year book depreciation produces a large deferred tax liability that reverses over the remaining book life, so the policy should flag how these entries get tracked.
Section 179 lets a business elect to deduct the full cost of qualifying property up to an annual cap. For tax years beginning in 2026, the maximum deduction is $2,560,000, phasing out dollar-for-dollar once you place more than $4,090,000 of qualifying property in service.7Office of the Law Revision Counsel. 26 USC 179 – Election to Expense Certain Depreciable Business Assets Section 179 is elected asset by asset; bonus depreciation applies automatically unless you opt out. The policy should say who decides and on what basis.
Luxury Auto and Listed Property Rules
If the company buys passenger vehicles, the policy needs its own section for them. Section 280F caps annual depreciation on passenger automobiles regardless of the vehicle’s cost or what MACRS would otherwise allow.8Office of the Law Revision Counsel. 26 USC 280F – Limitation on Depreciation for Luxury Automobiles
For passenger vehicles placed in service in 2026 with bonus depreciation, the caps are $20,300 in year one, $19,800 in year two, $11,900 in year three, and $7,160 for each following year. Without bonus depreciation, the year-one cap drops to $12,300. Cost above the annual cap carries forward at the succeeding-year rate until the depreciable basis is fully recovered.
There’s also a usage rule. If business use of a listed property asset falls to 50% or below in any year, you lose MACRS on it, switch to the alternative depreciation system, and recapture excess depreciation from prior years. The policy should require contemporaneous usage logs for any vehicle or equipment that could serve a dual business-personal purpose.
Handle Changes in Estimates and Methods
Business conditions change and depreciation assumptions eventually need updating. The document should state how each kind of change gets handled.
When new information tells you an asset will last longer or shorter than expected, that’s a change in accounting estimate. Treatment is prospective: take the current book value, subtract any revised salvage value, and spread the remainder over the new remaining life. You don’t restate prior periods, because the original estimate was reasonable when made.
Changing methods is less common and needs stronger justification. Under U.S. GAAP, a change in depreciation method for long-lived assets is treated as a change in accounting estimate effected by a change in accounting principle, applied prospectively; IFRS treats it the same way.9IAS Plus. IAS 8 – Accounting Policies, Changes in Accounting Estimates and Errors Either way, you must disclose the change and its effect in the footnotes.
Build In Impairment Triggers
Depreciation assumes an asset will deliver value over its full useful life, but sometimes circumstances change abruptly. When events suggest an asset’s carrying value may not be recoverable, U.S. GAAP requires an impairment test, and any resulting loss hits the income statement immediately. Once recorded, the reduced carrying amount becomes the new basis for future depreciation, and U.S. GAAP does not allow reversal if the asset later rebounds.
What the policy needs to specify is what triggers a review. Common triggers include a significant decline in market value, a major change in how the asset is used, and operating losses that suggest an asset group won’t break even. Naming the triggers in advance keeps impairment from becoming a judgment call made only when a bad year is already visible.
Flag Depreciation Recapture on Disposals
The policy should remind everyone that depreciation deductions come with a bill on the back end. When you sell equipment or other tangible personal property at a gain, the portion of the gain equal to prior depreciation deductions is taxed as ordinary income rather than at the capital gains rate under Section 1245.10Office of the Law Revision Counsel. 26 USC 1245 – Gain From Dispositions of Certain Depreciable Property Section 179 deductions and bonus depreciation count as depreciation for this purpose, so an asset fully expensed in year one triggers full recapture if sold at a gain.
Real property under Section 1250 gets more favorable treatment: only depreciation claimed above straight-line is recaptured as ordinary income, and because most post-1986 buildings use straight-line under MACRS, that ordinary-income recapture rarely applies.11Office of the Law Revision Counsel. 26 USC 1250 – Gain From Dispositions of Certain Depreciable Realty The straight-line depreciation you did claim gets taxed at a maximum 25% rate as unrecaptured Section 1250 gain, which is higher than the standard long-term capital gains rate.
Whoever handles asset dispositions should build the recapture tax into any sale-versus-hold analysis, and the policy should say so.