Is Depreciation an Operating Expense? Here's a Clear Answer
You bought a laptop for your business three years ago. Today, it's worth maybe half what you paid. That drop in value is depreciation, and it can matter more for your taxes and financial picture than you might realize.
Small business owners often ask, "Is depreciation an operating expense?". The answer affects how you track your business costs and can impact your tax deductions. Let's clear this up once and for all!
What Is Depreciation in Accounting?
Depreciation is accounting's way of recognizing that your business assets lose value over time. In other words, your shiny new equipment doesn't stay shiny and new forever!
Depreciation spreads the cost of a business purchase across several years instead of taking the full hit upfront.
When you buy a $3,000 computer, traditional depreciation would spread that cost over three years at $1,000 per year.
However, under the One Big Beautiful Bill Act signed in July 2025, businesses can now elect 100% bonus depreciation for qualified property acquired after January 19, 2025.
This means you could potentially expense the entire $3,000 in the first year instead of spreading it over multiple years, which provides immediate tax benefits.
Common examples of assets that small businesses deal with are:
Computers and software
Office furniture and fixtures
Tools and equipment
Vehicles used for business
Manufacturing or production equipment
Depreciation matters because it gives you a more accurate picture of your business costs each year. Plus, depreciation creates tax deductions that can lower your taxable income over multiple years.
What Are Operating Expenses?
Operating expenses are the day-to-day costs in your business. These are your regular, recurring expenses, such as utilities, office supplies, marketing and advertising, and software subscriptions.
Operating expenses are different from capital expenditures (like buying equipment) because they're consumed within the same accounting period.
Is Depreciation an Operating Expense?
Yes, but with a caveat.
Depreciation is classified as an operating expense on your income statement. It represents the cost of using your business assets during the current period. However, depreciation is what accountants call a "non-cash" operating expense.
Depreciation reduces your reported profit, but no money actually leaves your bank account. You already paid cash when you bought the asset. Now you're just spreading that cost across multiple years on paper.
This distinction matters for your cash flow planning because when you look at your profit and loss statement, you might see a $2,000 depreciation expense that makes your profits look smaller. But your checking account balance didn't drop by $2,000 that month.
Understanding this difference helps you separate your cash flow from your accounting profit.
This matters when planning expenses, applying for loans, or figuring out how much cash you have available to reinvest in your business.
Depreciation Expense Example
Let's say you run a consulting business and buy a $6,000 computer setup in January. Instead of expending the full $6,000 immediately, you depreciate it over three years using straight-line depreciation.
Here's how it works:
Total cost: $6,000
Useful life: 3 years
Annual depreciation: $6,000 ÷ 3 = $2,000 per year
Each year for three years, your income statement shows a $2,000 depreciation expense and your taxable income decreases by $2,000, but your cash flow is unchanged because you've already spent the $6,000 in January.
After three years, the computer is "fully depreciated" on your books. If you sell it for $500, you'd report a $500 gain because its book value is now zero.
For equipment purchased after January 19, 2025, the One Big Beautiful Bill Act allows businesses to elect 100% bonus depreciation.
This means you could potentially deduct the full $6,000 in year one instead of spreading it over three years, though you'd want to consult with your tax professional to determine the best strategy for your situation.
Why This Matters
Depreciation affects three important areas of your small business:
Tax savings: Depreciation creates tax deductions that reduce your taxable income.
Financial reporting accuracy: Depreciation matches expenses with the periods you benefit from the asset. This gives you a clearer picture of your true business costs each year.
Cash flow planning: Knowing that depreciation is non-cash helps you understand the difference between profit on paper and money in the bank. A business can be profitable but cash-poor, or have low profits but strong cash flow.
If you need help making sense of depreciation, a bookkeeping & tax professional can help you figure it out.
Common Depreciation Expense Mistakes to Avoid
Confusing Depreciation with Cash Expenses
Don't panic when you see depreciation on your financial statements. This represents money you already spent, not new expenses hitting your bank account. Some small business owners mistakenly think they need to set aside cash to "pay for" depreciation each month.
Not Tracking Depreciation Properly
Some small business owners skip tracking depreciation because it feels complicated. This creates two problems: your financial statements don't reflect reality, and you miss out on valuable tax deductions. Use accounting software or work with a bookkeeper to track depreciation.
Missing Out on Tax Benefits
The IRS offers accelerated depreciation methods and bonus depreciation rules that let you deduct more upfront. Section 179 deductions (now increased to $2.5 million under the 2025 legislation) and the restored 100% bonus depreciation can let you expense the full cost of qualified equipment purchases immediately.
Consult a tax professional to maximize these benefits!
FAQs
Why Is Depreciation Classified as an Expense?
Depreciation is classified as an expense because it represents the cost of using business assets to generate revenue during a specific period. Even though you paid cash for the asset upfront, accounting principles require matching expenses with the periods they help produce income.
Your $5,000 printer doesn't just benefit your business in the year you bought it, it helps generate revenue for several years. Depreciation spreads that $5,000 cost across those years, giving you a more accurate picture of what it costs to run your business each period.
When to Record Depreciation Expenses?
You record depreciation expenses monthly or annually, depending on how often you prepare financial statements. Most small businesses record depreciation annually through their accounting software, which automatically calculates and posts the entries.
Is Depreciation an Operating or Investing Expense?
Depreciation is an operating expense, not an investing expense. Operating expenses appear on your income statement and reduce your business profit. Investing expenses relate to activities like buying or selling investments, lending money, or acquiring other businesses. These appear in the investing section of your cash flow statement. Since depreciation represents the cost of using assets in your daily business operations, it belongs with your other operating expenses like rent, utilities, and supplies.
Together in Every Number with Desi Tax Service®
Our clients save thousands every year because we catch the mistakes that cost small business owners big money:
Miscategorized expenses (like putting depreciation in the wrong category)
Bookkeeping errors
Mixed-up business and personal expenses
Wrong filing status
Misreported income
Employee classification errors
Simple data entry mistakes
AND MORE! Small mistakes create big tax bills, but they're completely preventable with proper bookkeeping and tax planning.
Ready to stop overpaying taxes? Book a consultation today or learn more about our bookkeeping and tax services!
