Depreciation is the loss in value of an asset over time, or the difference between what you paid for something and what it's worth right now. It is typically applied to tangible or physical assets, like vehicles and furniture, but it can also apply to intangible assets like stocks and savings accounts. Find out how depreciation works, how it differs from appreciation and what types of assets typically depreciate.
How Does Depreciation Work?
Depreciation takes into consideration the cost of using an asset and the benefit gained over its useful life. An item's depreciation can take place due to normal wear and tear or regular use over multiple years and can pertain to vehicles, computers and electronics, toys, furniture, machinery and even wedding gowns.
Businesses regularly calculate depreciation to get certain tax and accounting advantages as their assets lose value over time. For individuals, a prime example of depreciation is how a new car's value plummets as soon as you drive it off the lot. Excluding specialty and exotic cars, depreciation is common with all vehicles.
Generally, cars lose more than 10% of their value in the first month and keep dropping from there, according to Carfax. In your first year of ownership, the value of your vehicle can plunge by almost 20%.
In five years, a new car has lost about 40% of its original value on average, according to a 2021 five-year depreciation study by iSeeCars.com. So, if you bought a new car at the dealership for $50,000, in five years, it may only be worth $30,000—or even less if it's in poor condition.
Of course, how much and how quickly an asset depreciates can also be based on factors like the asset's projected reliability, collectible value, expected useful life and supply and demand.
To illustrate, although the average vehicle depreciates about 40% over the first five years, some cars, like the Jeep Wrangler, have an average five-year depreciation of only 9.2%, according to the 2021 iSeeCars.com study. On the flip side, the Nissan LEAF has an average five-year depreciation of 65.1%.
How to Calculate Depreciation
There are several methods used to calculate depreciation, primarily by businesses looking to depreciate assets such as equipment, property, vehicles and the like. A common calculation is the straight-line method, where you subtract what you expect the asset will be worth at the end of its useful life from its original cost. Then, divide that number by the number of years of use.
Let's say you purchase a leather sofa for $1,200. You expect to use the sofa for 10 years, and after that time, sell it for $400. Using the straight-line method, the annual depreciation of your sofa would be $80.
$1,200 - $400 / 10 = $80
While you may not be too concerned about the return you'll get on a piece of furniture you plan to use for many years, businesses often use the straight-line method to depreciate assets because of its simplicity, consistency and ease of use when it comes to tax time.
Depreciation vs. Appreciation
The opposite of depreciation is appreciation, which is the increase in the value of an asset, such as land, fine wine or artwork, over time. This increase in value can happen for different reasons, like a reduction in supply or increased desirability in the market. Financial assets, such as certificates of deposit (CDs), stocks and bonds, savings accounts and real estate can all appreciate.
For instance, if the value of your house increases due to demand for housing in your area or improvements you've made, then the current value of your home is higher than it was when you bought it. It has appreciated in value.
However, if there is a downturn in the value of real estate in your area, or your home has been damaged or not maintained properly, your home may be worth less than the original purchase price. In this case, it has depreciated in value.
Assets That Typically Depreciate
Both tangible and intangible items can depreciate.
Items can depreciate or appreciate over time for various reasons. For instance, land (as a general rule) is expected to appreciate over a period of time. However, if land becomes abundant in a particular area or values plunge, it may depreciate from the original purchase price.
Assets that generally depreciate include:
|Computers, cellphones and other electronics||Furniture and fixtures|
Assets That Typically Appreciate
Appreciating assets can be both tangible and intangible. Keep in mind that, while some assets appreciate more quickly than others, there is no guarantee an asset will appreciate.
Assets that generally appreciate over time include:
|Mutual funds, exchange-traded funds, bonds and some stocks||CDs|
|Homes||Whole life insurance policies|
|Land||Works of art|
|Savings accounts||Silver and gold|
The Bottom Line
Depreciation occurs when an asset loses value over time, usually due to wear and tear or just everyday use. Appreciation is just the opposite.
Although the depreciation of assets isn't a given, there are parts of your financial health that are, such as the importance of your credit. To find out where you stand, access your free credit score and credit report at any time with Experian.