Restauranteur's Guide to Kitchen Equipment Depreciation Rate
Calculating your kitchen equipment depreciation rate is an important way for your business to get the most out of its tax returns. Depreciation is something restaurants must consider when purchasing new or used equipment because it's a way to offset acquisition, installation, and maintenance costs over the item's useful life. Accounting for kitchen equipment depreciation helps your business prepare for the replacement of essential tools. The tax benefits could also improve your bottom line come tax time.
The 15-Year Rule for Restaurant Kitchen Equipment
Under the Protecting Americans from Tax Hikes Act (2015), the recovery period for a restaurant is limited to 15 years. Before this act was passed, depreciation on non-residential real estate was calculated over 39 years, meaning that depreciation was very slow.
In 2023, the 15-year depreciable life still stands, but this type of property may not be eligible for Bonus Depreciation unless it meets certain requirements. With the effect of the pandemic still being felt, it’s important for restaurant owners in Jacksonville, Florida, and around the country to be aware of all the restaurant tax deductions available to them in addition to depreciation.
IRS Depreciation Methods and MACRS Categories
The MACRS method (Modified Accelerated Cost Recovery System) comprises two main sub-categories: the GDS (General Depreciation System) and the ADS (Alternative Depreciation System). Within the GDS method, there are a few options businesses can use to calculate depreciation deductions. An expert in restaurant accounting services can advise you on the best method to use in your business.
Straight-Line Depreciation
The Straight-Line Depreciation method is an easy way to determine the amount of depreciation expense you can claim each year. The Straight-Line Depreciation method involves estimating an asset's useful life and salvage value at the end of its useful life. The depreciation of the item is then expensed for each year of the asset's estimated useful life. The Straight-Line Depreciation formula is:
Annual Depreciation = (Cost of Asset - Salvage Value) / Useful Life
Example: Your company buys an industrial oven for $10,000 with an estimated salvage value of $2,000 and a useful life of five years:
Cost of Asset - Salvage Value = $8,000
Useful life of the asset = five years
$8,000 / 5 = $1,600 annual depreciation value
Declining Balance Depreciation
This method has two iterations: the standard Declining Balance Method and the Double-Declining Balance method. Both are types of accelerated depreciation used to depreciate equipment quickly at the start of the item's useful life rather than more slowly over the entirety of its life. The Double-Declining Balance equation works in the same way but accelerates the depreciation even more.
This method offers a more aggressive way to depreciate compared to the straight-line depreciation rate. Calculating depreciation in this way is advantageous when applied to items that lose their value quickly, like technology.
Annual Depreciation Amount = (Book Value at the beginning of the year - Salvage Value) x Depreciation Rate (%)
Example: You buy a mixer costing $1,000 with a 10-year useful life and a salvage value of $100. If it depreciates at 30% per year, it will depreciate $270 in the first year, $189 in the second year, $132 in the third year, etc.
Alternative Depreciation System
While many businesses may wish to depreciate their assets quickly, some prefer to do it slower to reduce their taxable income over a more extended period of time.
To calculate depreciation expenses, use the following formula:
(Cost of Asset - Salvage Value) / Applicable ADS Recovery Period
Example: You purchase a kitchen fan for $50,000 which has a 10-year ADS recovery period and a $5,000 salvage value.
($50,000 - $5,000) / 10 years = $45,000
$45,000 / 10 = $4,500 annual deduction
Other Depreciation Methods
In addition to the methods described above, there are two other popular methods for calculating depreciation for accounting purposes.
Sum-of-the-Years' Digits Depreciation
This is an accelerated depreciation method that’s similar to the Declining Balance Method, but not as aggressive. It is appropriate for items that lose value quickly.
Depreciation: Current Book Value - (Remaining Lifespan / SYD depreciation x [Cost of the Asset - Salvage Value])
Example: You install a walk-in freezer for $130,000 with a five-year estimated useful life. Its salvage value is $30,000, leaving your total depreciation expense at $100,000.
First year: $130,000 - (5 / 15 x $100,000) = $33,333.33
Second year: $96,666.67 - (4 / 15 x $100,000) = $26,666.67
Third year: $70,000 - (3 / 15 x $100,000) = $20,000
Fourth year: $50,000 - (2 / 15 x $100,000) = $13,333.33
Fifth year: $36,666.67 - (1 / 15 x $100,000) = $6,666.67
Units of Production Depreciation
Companies can use this method to calculate depreciation for assets whose value derives from the number of units it produces instead of its lifespan. In a restaurant, this could be especially relevant to a piece of equipment that must produce a certain number of batches in an hour or a day.
Depreciation: (Asset Cost - Salvage Value) / Estimated Units over Asset's Lifetime x Actual Units Made
Example: Your kitchen needs a machine that produces several units per day and costs $250,000. It's expected to produce 120,000 units in its lifetime and has a salvage value of $10,000.
Depreciable amount = $240,000
$240,000 / 120,000 units = $2 depreciation per unit
If the machine produces 5,000 units in the first year, depreciation will be $10,000 (5,000 x $2). This will continue until the $240,000 limit is reached.
Details to Be Determined Before Calculating Depreciation
Several variables need to be established in order to calculate depreciation. These are:
The Basis
The basis of an item can be calculated on a cost or adjusted basis. The main basis will be its cost to your business including purchase price, delivery, and any other purchase costs.
An adjusted basis of assets occurs when something happens to increase or decrease an item's basis such as the theft or loss of one part of the asset.
Start and End Dates
Equipment depreciation starts when you first place the item in service in your business to produce income, or when the item is ready and available for use. Depreciation ends when you've fully recovered the cost or other basis or when it's retired from service, whichever happens first.
The Convention
The convention is used to determine how much depreciation can be claimed at the beginning and end of an item’s useful life when the asset is only “in service” for part of the tax year. Further information about which convention applies can be found on the IRS website.
Rate of Depreciation
The depreciation rate will depend on the method you choose in your business. Whereas many businesses benefit from an accelerated depreciation rate, others may choose to extend depreciation over a longer period of time to take advantage of lower taxable income during that period.
Section 179 Rules
Section 179 allows restaurant owners to deduct some or all of the cost of qualifying property in one go rather than depreciating the asset over time. Bear the following in mind:
Section 179 can be used to recover 100% of the depreciation expenses for an asset in the tax return that applies to the year in which you purchased the asset, up to the relevant limit for that tax year.
The deduction amount can’t exceed your earned income for that tax year.
Tax years starting in 2023 are subject to a maximum Section 179 expense deduction of $1,160,000.
The phase-out threshold for 2023 is $2,890,000.
Bonus Depreciation is currently being phased out. In previous years, restaurant owners could depreciate 100% of qualifying property that exceeded the Section 179 limit. This provision will be reduced to 80% for qualifying purchases made during the 2023 tax year.
Tax Professionals Can Help
Because depreciation can make a significant financial difference to your restaurant, it's important to get it right. Getting help from an expert gives you the peace of mind that your business is getting the most out of its tax return.
Understanding the different methods of depreciation can help you choose the method that is most advantageous to your business. Up-to-date information about asset depreciation can also help you make strategic decisions about purchasing or replacing assets vs. performing repairs to extend their useful life.
