Depreciation

How Depreciation Works

When a business buys a $60,000 service vehicle, the full $60,000 isn't expensed in year one — it's capitalized (put on the balance sheet) and depreciated over its useful life. Under MACRS (IRS standard), vehicles are typically depreciated over 5 years. Result: $12,000/year in depreciation expense, reducing taxable income for 5 years.

Standard MACRS Depreciation Lives

• 5-year property: Cars, trucks, computers, office equipment
• 7-year property: Office furniture, most manufacturing equipment
• 15-year property: Land improvements (parking lots, fencing)
• 27.5-year property: Residential rental real estate
• 39-year property: Commercial real estate

Why Depreciation Is Added Back in EBITDA

EBITDA adds back depreciation because it's a non-cash charge — no money left the business when the depreciation entry was made. EBITDA is designed to approximate operating cash flow, stripping out accounting entries that don't reflect actual cash movements.

Depreciation vs. CapEx: The Correction

Depreciation represents assets wearing out. CapEx represents replacing them. A business that depreciates $40K/year in equipment but spends $0 in CapEx is running its assets into the ground — eventually a large replacement bill will arrive. This is why free cash flow (EBITDA minus maintenance CapEx) is more accurate than EBITDA alone for capital-intensive businesses.

Bonus Depreciation and Section 179

IRS elections (bonus depreciation and Section 179) allow businesses to immediately expense certain assets rather than depreciate them over time. This accelerates tax deductions — which is great for the seller's tax planning but can make historical P&L harder to normalize for buyers.