Depreciation vs. Amortization vs. Depletion: Key Differences for US Businesses
As a business owner or financial professional, understanding how to properly account for asset expenses is crucial for accurate financial reporting and tax compliance. Three key concepts—depreciation, amortization, and depletion—help allocate the cost of assets over time. While they serve similar purposes, they apply to different types of assets under U.S. GAAP and IRS tax rules.
This guide breaks down each method, their tax implications, and how they impact your financial statements.
1. Depreciation: Spreading Out Tangible Asset Costs
Definition: The systematic allocation of a tangible asset’s cost over its useful life.
Applies To:
Machinery, vehicles, buildings, office equipment
Land cannot be depreciated (it doesn’t wear out)
Key IRS Rules:
Modified Accelerated Cost Recovery System (MACRS) is the standard method for tax depreciation.
Recovery Periods:
Computers/office equipment: 5 years
Vehicles: 5 years
Commercial real estate: 39 years
Bonus Depreciation (2025):40% first-year deduction (phasing down)
2. Amortization: Writing Off Intangible Assets
Definition: The gradual expensing of intangible assets over their useful life.
Applies To:
Patents, copyrights, trademarks
Franchise agreements, software development costs
Goodwill (amortized over 15 years for tax purposes)
Key IRS Rules:
Section 197 Intangibles: Most amortized over 15 years (straight-line).
Software Costs:
Purchased software: 3-year amortization (unless under Section 197)
Self-developed software: Eligible for R&D tax credits
Example:
Your company acquires a patent for $30,000.
Annual amortization: $2,000/year (15 years)
3. Depletion: Accounting for Natural Resources
Definition: Allocating the cost of natural resource extraction (e.g., oil, timber, minerals).
Applies To:
Oil & gas wells, coal mines, timberlands
Two methods:
Cost Depletion: Based on units extracted
Percentage Depletion (IRS only): Fixed % of gross income (limits apply)
Key IRS Rules:
Percentage Depletion Rate: Varies by resource (e.g., 15% for oil & gas).
Independent producers get special tax advantages.
Example:
An oil company invests $1 million in a well expected to produce 500,000 barrels.
Cost depletion: $2 per barrel deducted as sold
Comparison Table: Depreciation vs. Amortization vs. Depletion
Factor
Depreciation
Amortization
Depletion
Asset Type
Tangible (e.g., equipment)
Intangible (e.g., patents)
Natural resources
Tax Method
MACRS
Straight-line (15 yrs)
Cost or % depletion
Key IRS Code
Sec. 168
Sec. 197
Sec. 613
Example
Factory machine
Trademark
Timberland
Why This Matters for Your Business
Tax Savings: Accelerated depreciation (like bonus depreciation) reduces taxable income.
Financial Reporting: GAAP requires proper matching of expenses with revenue.
Audit Protection: Misclassifying assets can trigger IRS scrutiny.
Depreciation, amortization, and depletion serve as fundamental tools for aligning asset costs with their productive use. While these concepts share the common goal of systematic cost allocation, their application varies significantly based on asset type and relevant tax regulations. For tangible assets, depreciation methods like MACRS offer flexibility in timing deductions. Amortization provides a structured approach for intangible assets, while depletion addresses the unique characteristics of natural resources. Proper implementation of these principles affects not only tax liability but also financial statement accuracy and business valuation. As tax laws and accounting standards evolve, maintaining current knowledge of these cost recovery mechanisms remains essential for sound financial management.