If you’re a business owner who uses computer software, it’s important to understand the concept of depreciation and how it applies to your software. Depreciation is the process of allocating the cost of an asset over its useful life. In other words, it’s a way of accounting for the wear and tear that occurs as an asset is used over time.
When it comes to computer software, there are different rules that apply depending on how you acquired the software and how you use it. Let’s take a closer look at the depreciation rate for computer software.
Depreciation Rate for Purchased Software
If you purchased computer software outright, meaning you own the license to use it indefinitely, you can depreciate the cost of the software over its estimated useful life. According to IRS Publication 946, “How To Depreciate Property,” computer software typically has a useful life of three years.
This means that if you spent $3000 on a piece of software, you could depreciate $1000 each year for three years. You would do this by taking the total cost of the software and dividing it by three. So in this example, your annual depreciation expense would be $1000.
It’s important to note that if you use accelerated depreciation methods such as Section 179 or bonus depreciation, you may be able to write off the entire cost of the software in one year.
Depreciation Rate for Cloud-Based Software
Cloud-based or subscription-based software is treated differently than purchased software when it comes to depreciation. Since cloud-based software is not owned outright but rather paid for on an ongoing basis, it is considered an operating expense rather than a capital expense.
This means that instead of depreciating the cost of cloud-based software over its useful life, you can deduct the entire cost as an operating expense in the year that it was paid for.
Understanding the depreciation rate for computer software is an important part of managing your business finances. If you purchased software outright, you can depreciate the cost over three years. If you use cloud-based software, you can deduct the entire cost as an operating expense in the year it was paid for.
Remember that there are different rules that apply depending on how you acquired and use your software, so be sure to consult with a tax professional if you have any questions or concerns.