6. A Lesson in Depreciation

You may be tempted to skip this part and leave it to the tax expert. Don't. You simply must know something about depreciation. We will try to keep it simple.

Suppose you use a car in your business. You buy a new car for $3,000. After five years, it is worthless. You have to shell out another $3,000 to buy a new car (if you are lucky and the price has not gone up). Where is the money to come from to buy that replacement car if you have to pay high taxes on every dollar that you take in during these five years? Uncle Sam has a heart. He knows about your troubles. He knows that your car depreciates to the point where it has no more value. In our example, he permits you to set aside every year one fifth of the car's cost or $600 on which you do not have to pay taxes. So, at the end of five years, you will have put aside the $3,000 to buy your new car.

To give another illustration, after a number of years, you may have to replace a machine which, although still in good working condition, is obsolete. Here too, you are permitted every year to set aside a certain sum tax free to replace that obsolete equipment. The money which you may set aside or pocket each year without having to pay income taxes is called a depreciation allowance or depre­ciation reserve. This is to compensate you for the loss in value of the equipment which you use in your business, and to permit you to accumulate the funds to buy new equipment.

Are You Ready To Move Onto The Next Lesson? Click Here...