Depreciation question: When does it become helpful to purchase equipment for depreciation write-offs? You have said that it doesn’t make sense to purchase equipment for tax purposes, but I was just wondering how that relates to depreciation because we don’t have much in depreciation?
Response: It makes as much sense to purchase equipment for depreciation write-offs as it does to get your landlord to raise your rent. In both cases you will make less money and pay less in taxes. And, contrary to some opinions, depreciation is a “real cash” expense as it’s never helpful to increase your expenses unnecessarily to avoid paying taxes.
The difference between equipment and rent is that the loss in equipment value isn’t known this year. If you buy $100,000 of equipment at the beginning of the year and sell it for $80,000 at the end; then “equipment expense” would be a clear $20,000.
But equipment lasts for more than a year (a good thing). Realistically, we buy it at the beginning of year one for $100,000 and sell it at the end of year five for $10,000. That means the cost of the equipment is $90,000 over the five years or an estimated $18,000 per year.
So we do have a real cash expense of $18,000 for the year, we just haven’t realized it yet. And when we do realize it, an adjustment will be made if it is somewhat more or less.
Therefore, we “estimate” the amount of equipment “used up” each year through depreciation even though it is a non-cash expenditure during that year.
Now, ask the question again.
Should we buy equipment so we will have more in depreciation expenses?
No. Should you hire extra people you don’t need so you will pay fewer taxes? Should you pay the landlord more so you will pay fewer taxes? Should you give raises so you will pay fewer taxes? For these same reasons, you should NOT buy equipment you don’t need just so you will pay fewer taxes.
Our goal should be to MAKE money, pay appropriate taxes and then keep it. It isn’t to spend money unnecessarily on equipment so we make no money and therefore not keep any.