The straight-line depreciation method and the double-declining-balance depreciation method:

Depreciation is a way of spreading out the cost of a capital asset over time. By using depreciation, the total cost of an asset is expensed over a number of years referred to as the useful life or recovery period. For tax purposes, the recovery periods for various types of assets are specified by the IRS in the United States.

The simplest method of depreciation is the straight line depreciation method, which simply deducts the cost of an asset evenly over the course of its recovery period. However, other methods of depreciation such as the declining balance method result in larger expenses in the early years of an asset's life. 

An organization can choose different methods of depreciation for financial reporting purposes and for tax purposes. The IRS specifies the depreciation method and rate that must be used for tax purposes in a system called the modified accelerated cost recovery system (MACRS). The two methods used under MACRS are the straight line method and the declining balance method.

This article will provide an overview of the straight line and declining balance depreciation methods and the relationship between depreciation method and cost segregation.

Depreciation Methods

Before discussing common depreciation methods in detail, it is important to understand the following terms:

• Salvage value is the book value of an asset at the end of its recovery period. The salvage value is what the business may expect to receive in exchange for selling the asset. The salvage value for many assets is zero.

• Useful life or recovery period, as previously mentioned, is the number of years over which an asset will depreciate for tax and accounting purposes

• Depreciable basis is the amount of an asset’s cost that is subject to depreciation. When an asset is placed in service, the depreciable basis is equal to its cost to you, less the salvage value. The depreciable basis decreases every year by the amount of depreciation expense claimed.

A Note About Depreciation in the First Year

Taxpayers are generally not allowed to claim a full year of depreciation during the first year an asset is placed in service. Instead, a partial year of depreciation is taken in the first year. Calculating this partial depreciation depends on the type of asset and the depreciation method being used. Some assets must be depreciated using the half-month, half-quarter, or half-year conventions. Details on how to implement these conventions can be found in IRS Publication 946.

For an asset with a five-year recovery period using the mid-year convention, the rate of depreciation in year one would be 10 percent. For years two through five, the depreciation rate would be 20 percent. In year six, the remaining 10 percent of depreciation would be claimed.

To more clearly illustrate the different depreciation methods, the partial year of depreciation will not be taken into account in the examples below. To determine the actual depreciation rate for tax purposes, you should consult the MACRS table appropriate to the asset’s recovery period, depreciation method, and in-service date.

Straight Line Depreciation

Straight line depreciation is the simplest method of depreciation. The yearly depreciation expense is equal to the depreciable basis of the asset divided by its recovery period. A five-year asset with a depreciable basis of $5,000 would be subject to $1,000 of depreciation per year

Expressed in terms of rate, the annual rate of depreciation is equal to 100 percent divided by the recovery period. A five-year asset using the straight line method would be subject to an annual depreciation rate of 20 percent. The 20 percent applies to the unadjusted basis of the asset.

Straight line depreciation allows taxpayers to claim a consistent deduction over the life of the asset. This method of depreciation can be advantageous if the company anticipates lower income in the early years of an asset’s life, since larger deductions are still available in later years. However, for assets with longer depreciable lives, such as commercial buildings, it can take years to write off a significant portion of the asset’s cost.

Declining Balance Depreciation

The declining balance method of depreciation is an accelerated depreciation method. This method results in larger depreciation deductions in the early years of business ownership. The yearly depreciation rate is equal to the declining balance percentage divided by the recovery period. The declining balance method uses a higher percentage than the straight line method. For example, the double declining balance method uses a percentage of 200 percent. For a five-year asset, the double declining balance rate would be 40 percent per year.

Multiply the declining balance rate by the adjusted basis to determine the depreciation expense. The adjusted basis is equal to the asset’s original basis minus accumulated depreciation. For a $5,000, five-year asset, the first-year depreciation would be $2,000 (40 percent of $5,000). In year two, the basis would be adjusted to $3,000, and the depreciation expense would be $1,200 (40 percent of $3,000).

For tax purposes, an asset must switch from the declining balance method to the straight line method beginning in the first year in which the straight line method would give an equal or greater deduction. MACRS tables account for this change in method.

The benefit of the declining balance method is that it allows for larger deductions in the early years of ownership. For taxpayers in need of more deductions, declining balance is often the preferred method.

Which Depreciation Method Should I Use?

The modified accelerated cost recovery system (MACRS) is generally the appropriate method to depreciate property for tax purposes in the United States. Detailed information on how to apply MACRS can be found in IRS Publication 946: How to Depreciate Property. The publication contains tables that outline the appropriate depreciation rate for an asset based on its recovery period, depreciation method, and in-service date.

Certain types of property are allowed to depreciate using the 150 percent or 200 percent declining balance method, which allows for increased depreciation in the early years of ownership. Other types of property, such as nonresidential and residential real property, must use the straight line method.

Taxpayers are generally allowed to elect for a more conservative method of depreciation. For example, if you determine that a five-year asset is eligible for depreciation using the 200 percent declining balance method under MACRS, you can elect to use either the 150 percent declining balance method or the straight line depreciation method instead.

Effects of Cost Segregation

Because the recovery periods and depreciation methods for tax purposes are specified by the IRS, there are limited ways of increasing depreciation. Nonresidential real estate will generally be depreciated using the straight line method over 39-years under MACRS. However, one way of increasing depreciation deductions is by reclassifying property using a cost segregation study.

A cost segregation study identifies portions of a building that are currently being treated as nonresidential or residential real property, but should in fact be classified as 5-,7-, or 15-year property. By reclassifying real property into categories with shorter recovery periods, cost segregation studies allow taxpayers to use more aggressive methods of depreciation such as 200 percent and 150 percent declining balance methods. For property that is already in service, this change in recovery period is implemented using a Form 3115. No amended tax returns are required to implement a cost segregation study.

Certain property with a useful life of 20 years or less qualifies for bonus depreciation, allowing for even larger deductions in the early years of ownership.

A portion of your real estate may be eligible for accelerated depreciation. Use our online form to request a no-cost projection of the tax savings available to you under the current law.

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Depreciation is the act of writing off an asset’s value over its expected useful life, and reporting it on IRS Form 4562. The double declining balance method of depreciation is just one way of doing that. Double declining balance is sometimes also called the accelerated depreciation method. Businesses use accelerated methods when having assets that are more productive in their early years such as vehicles or other assets that lose their value quickly.

If you’re brand new to the concept, open another tab and check out our complete guide to depreciation. Then come back here—you’ll have the background knowledge you need to learn about double declining balance.

The most basic type of depreciation is the straight line depreciation method. You use it to write off the same depreciation expense every year. So, if an asset cost $1,000, you might write off $100 every year for 10 years. Your annual depreciation amount never changes.

On the other hand, with the double declining balance depreciation method, you write off a large depreciation expense in the early years, right after you’ve purchased an asset, and less each year after that. So the amount of depreciation you write off each year will be different.

Double declining balance is calculated using this formula:

2 x basic depreciation rate x book value

Basic depreciation rate

Your basic depreciation rate is the rate at which an asset depreciates using the straight line method.

To get that, first calculate:

Cost of the asset / recovery period

Cost of the asset is what you paid for an asset. Recovery period, or the useful life of the asset, is the period over which you’re depreciating it, in years.

Once you’ve done this, you’ll have your basic yearly write-off. You can use this to get your basic depreciation rate.

Basic yearly write-off / cost of the asset

The result is your basic depreciation rate, expressed as a decimal. (You can multiply it by 100 to see it as a percentage.) This is also called the straight line depreciation rate—the percentage of an asset you depreciate each year if you use the straight line method.

Book value

Every year you write off part of a depreciable asset using double declining balance, you subtract the amount you wrote off from the asset’s book value on your balance sheet. Starting off, your book value will be the cost of the asset—what you paid for the asset.

That number goes down each year, as you subtract the amount you wrote off.

When accountants use double declining appreciation, they track the accumulated depreciation—the total amount they’ve already appreciated—in their books, right beneath where the value of the asset is listed. If you’re calculating your own depreciation, you may want to do something similar, and include it as a note on your balance sheet.

Confused yet? Don’t worry—these formulas are a lot easier to understand with a step-by-step example.

There are a few benefits to the double depreciation method.

You can match maintenance costs

Some depreciable assets—vehicles, for instance—work smoothly when you first buy them, but require more maintenance over time. Luckily, that maintenance is tax-deductible. Double declining depreciation lets you get a bigger tax write-off in the earlier years, when you aren’t writing off maintenance costs.

In later years, as maintenance becomes more regular, you’ll be writing off less of the value of the asset—while writing off more in the form of maintenance. So your annual write-offs are more stable over time, which makes income easier to predict.

You can cover more of the purchase cost upfront

You get more money back in tax write-offs early on, which can help offset the cost of buying an asset. If you’ve taken out a loan or a line of credit, that could mean paying off a larger chunk of the debt earlier—reducing the amount you pay interest on for each period.

You can reduce your tax obligation when it counts

Some assets make you more money right after you buy them. (An example might be an apple tree that produces fewer and fewer apples as the years go by.) Naturally, you have to pay taxes on that income. But you can reduce that tax obligation by writing off more of the asset early on. As years go by and you deduct less of the asset’s value, you’ll also be making less income from the asset—so the two balance out.

Like anything else, double declining balance has its downsides.

You’ll have to do more math, or get an accountant’s help

Bottom line—calculating depreciation with the double declining balance method is more complicated than using straight line depreciation. And if it’s your first time filing with this method, you may want to talk to an accountant to make sure you don’t make any costly mistakes.

Your income may become harder to predict

If you file estimated quarterly taxes, you’re required to predict your income each year. Since the double declining balance method has you writing off a different amount each year, you may find yourself crunching more numbers to get the right amount. You’ll also need to take into account how each year’s depreciation affects your cash flow.

You may regret taking more money upfront

If something unforeseen happens down the line—a slow year, a sudden increase in expenses—you may wish you’d stuck to good old straight line depreciation. While double declining balance has its money-up-front appeal, that means your tax bill goes up in the future. That can be tough if the extra money is sorely needed.

So, you just bought a new ice cream truck for your business. Congratulations! Now you’re going to write it off your taxes using the double depreciation balance method.

The truck cost $30,000. Under IRS rules, vehicles are depreciated over a 5 year recovery period.

Step one

Figure out the basic yearly write-off for the truck.

30,000 / 5 = $6,000

Step two

Figure out the straight-line rate of depreciation for the truck.

6,000 / 30,000 = 0.2 (or 20%)

Step three

Calculate the book value of the truck.

(Each year, you subtract the amount you depreciated over previous years from the book value. This is our first year of depreciating this asset, though, so it won’t change.)

30,000 – 0 = $30,000

Remember to do this step every year.

Step four

Enter the straight line depreciation rate in the double declining depreciation formula, along with the book value for this year.

(2 x 0.2) x (30,000) = $12,000

In the first year of service, you’ll write $12,000 off the value of your ice cream truck. It will appear as a depreciation expense on your yearly income statement.

Remember—you need to recalculate the book value every year. So you might as well make a note now:

30,000 – 12,000 = $18,000

Next year when you do your calculations, the book value of the ice cream truck will be $18,000.

How to plan double declining balance depreciation

For the second year of depreciation, you’ll be plugging a book value of $18,000 into the formula, rather than one of $30,000.

We won’t show the math here. But, spoiler warning: in the second year, you’ll write off $7,200. That will also be subtracted from the $18,000 book value, bringing it down to $10,800 in the third year.

To create a depreciation schedule, plot out the depreciation amount each year for the entire recovery period of an asset.

Three things to note:

1- You can’t use double declining depreciation the full length of an asset’s useful life. Why? Since it always charges a percentage on the base value, there will always be leftovers.

Here’s an example. Let’s say you have a bottle of really nice wine. You want to make it last, so you resolve to only drink half of the wine each day. On Monday you drink half the bottle. On Tuesday, you drink half of what’s left.

By Wednesday, you have one quarter of a bottle left. So, you drink half of that. On Thursday, you have one eighth left, and you drink half of that—so you’ve only got one sixteenth left for Friday. And so on—as long as you’re drinking only half (or 50%) of what you have, you’ll always have half leftover, even if that half is very, very small.

2- Eventually, you’ll have to switch from double declining depreciation to the straight line method. It’s the only way to make sure you depreciated the entire value of an asset—or “drink all of the wine.”

Typically, accountants switch from double declining to straight line in the year when the straight line method would depreciate more than double declining. For instance, in the fourth year of our example, you’d depreciate $2,592 using the double declining method, or $3,240 using straight line. That’s when you’d make the switch.

3- Once it’s fully depreciated, you list the asset’s salvage value on the books. After an asset is fully depreciated, its book value doesn’t become $0. Instead, it becomes that asset’s salvage value. The salvage value is the fair market price of an asset after the end of its useful life.

Say your ice cream truck cost $30,000 brand new. After a five year recovery period, you’ve completely written it off. Doing some market research, you find you can sell your five year old ice cream truck for about $12,000—that’s the salvage value. So the truck’s book value is now $12,000.

To get a better grasp of double declining balance, spend a little time experimenting with this double declining balance calculator. It’s a good way to see the formula in action—and understand what kind of impact double declining depreciation might have on your finances.

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Ready to file your taxes? Learn how to report depreciation, one step at a time, with our guide to Form 4562.