Depreciation under Income Tax Act – Meaning

Depreciation is discussed in Section 32 of the Income Tax Act of 1961. Depreciation is characterized as a decrease in the value of an object caused by wear and tear. People claim depreciation deductions only for accounting or taxation purposes. 

The Income Tax Act of 1961 provides for the deduction of all real and intangible properties. In the case of a capital asset, it can be deducted from the cost of the home, factory, and equipment. In the case of an intangible possession, a deduction can be claimed against patents, trademarks, copyright, warrant, franchise, or any other related corporate or contractual privilege. The deduction on depreciation on those assets which are used by the assessee for the purpose of business or profession in the previous year.

If an object has been in service for more than 180 days, a depreciation of 50% is permitted in that year. The assessee doesn’t need to have used the properties in the prior year to profit from the depreciation deduction. If an assessee purchases an asset and then leases it to a lessee, the assessee may seek depreciation under the Act.

Depreciation Rate

Rates of depreciation on assets:

  • Residential Building: 5%
  • Non-residential Building: 10%
  • Furniture and Fitting: 10%
  • Computers and Software: 40%
  • Plant and Machinery: 15%
  • Personal Use Motor Vehicle: 15%
  • Commercial Use Motor Vehicle: 30%
  • Ships:  20%
  • Aircraft: 40%
  • Tangible Assets: 25%

Claiming Depreciation as Per Income Tax Act

An assessee must meet certain requirements to claim the depreciation deduction. The below are the conditions:

Assets Classifications: The owner of the asset must be an assessee to benefit from depreciation. The asset can be both real and intangible. In terms of a tangible asset, it can be a home, equipment, factory, or furniture. Intangible properties may be patent rights, copyrights, trademarks, licenses, franchises, or something of a similar type gained on or after April 1, 1998. The income tax department estimates only the depreciation on the house when estimating depreciation. They may not factor in the expense of the property on which the building is built. The justification for not incorporating the cost of the property in the house is that the land does not depreciate due to wear and tear or use.

Lease Vs Ownership: An assessee can seek depreciation only on capital assets that he owns. If the assessee wishes to take advantage of the allowance for property depreciation, the assessee must be the owner of such properties. An assessee doesn’t need to be the owner of the property. Where an assessee constructs a house but the property belongs to someone else, he is entitled to a credit for depreciation on houses. The assessee cannot seek the deduction if he is a resident who uses the house. Where an assessee has taken a mortgage on the property and built a dwelling on that land, he is entitled to depreciation allowances. In the case of hire and buy, if an assessee contracts the equipment for a brief amount of time, he cannot demand the deduction. However, in the event of a loan, if an assessee acquires the property and becomes the purchaser, he is eligible to receive the deduction.

Used for Professions or Business: The commodity may have been used for a company or occupation to qualify for the credit for depreciation. However, it is not required to claim the credit on depreciation, for which an assessee must use the asset during the fiscal year. Thus, if the assessee uses the asset for a short amount of time within an accounting year, he is entitled to depreciation deductions. Take, for example, every seasonal factory.

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On Sold Assets: Depreciable assets cannot be deducted by an assessee. If an object is sold, removed, or damaged in the same year that it was bought, the assessee is not eligible to receive the deduction.

Co-ownership: If an asset has a co-owner, the co-owner may report depreciation on the asset as well.

Different Methods of Depreciation Calculation

Methods of Depreciation and the useful life of depreciable assets may vary from asset to asset. Based on asset type and industry, it can differ for accounting and taxation purposes also. The most commonly employed methods of depreciation are the Straight Line Method and the Written Down Value Method. One of the basic differences in income tax depreciation calculation and companies act depreciation other than rates of depreciation is the method of calculation.

On Depreciation as per Companies Act, 1956

  • Straight Line Method
  • Written Down Value Method

On Depreciation as per Companies Act, 2013

  • Straight Line Method
  • Written Down Value Method
  • Unit of Production Method

On Depreciation as per Income Tax Act, 1961:

  • Written Down Value Method (Block wise)
  • Straight Line Method for Power Generating Units

Depreciation under Income Tax Act – FAQs

Q1. How is depreciation calculated under the Income Tax Act?

According to Section 32(1) of the Income Tax Act of 1961, depreciation shall be measured at the specified percentage on the WDV of the asset, which is determined concerning the asset’s actual expense. When an assessee purchases an asset within the past year, the real expense becomes the WDV.

Q2. What is depreciation under the Income Tax Act?

Depreciation is a deduction permitted under the Income Tax Act for the decrease in the actual value of a tangible or intangible product used by a taxpayer.

Q3. When an asset is sold, how do you measure depreciation under the Income Tax Act?

WDV of an asset = Real expense to the assessee – All depreciation given to him (including unabsorbed depreciation, if any) 

WDV of a Block of Assets

Q4. When can I claim depreciation?

To benefit from deflation, the following requirements must be met: Condition 1: The assessee must own the asset. Condition 2: It cannot be used for commercial or professional purposes. Condition :3 It must have been used in the previous year.

Q5. Which method of depreciation calculation is used for tax purposes?

Tax depreciation is measured using the Modified Accelerated Cost Recovery System, or MACRS, while financial depreciation is calculated using the straight-line process, which results in an equal distribution of the loss over the life of the asset.