Self-employed people, business owners and freelancers are responsible for maintaining proper accounts for their businesses. It is important to consider the depreciation of fixed assets as a significant factor when it comes to financial planning and management. In this article, we will explain what depreciation is and which assets can be depreciated. We will also examine the different depreciation methods and explain how depreciation can be calculated.

What's in this article?

• What is depreciation?
  
• Which assets can be depreciated?
  
• What is straight-line depreciation?
  
• What is reducing balance depreciation?
  
• What other forms of depreciation exist?
  
• How is depreciation calculated?
  

What is depreciation?

In Germany, depreciation is known as AfA – short for "Absetzung für Abnutzung" or "deduction for wear and tear". AfA, or depreciation, is an important instrument in the realm of tax law and is used to calculate various types of income and returns. Businesses and self-employed people can use the concept of depreciation to deduct expensive acquisition costs from their taxes over a prolonged period of time. Section 7 of the German Income Tax Act (EStG) outlines that the acquisition and production costs of an asset may be distributed over the period of its useful life – provided that the asset is expected to be used by the business for longer than one year. The costs for these items, also referred to as fixed assets, are therefore not tax-deductible in full as a one-off, but are taken into account in annual increments. Using this method, the asset is "written off" in the tax balance sheet. This is due to the natural wear and tear of every asset, which leads to a gradual loss of value over time.

Businesses can use depreciation to reduce their taxable profits and thus lower their tax burden. This can lead to better liquidity. It is therefore important to recognise which assets can be depreciated over which period of time and via which method.

Which assets can be depreciated?

Assets that have been purchased or manufactured must meet four conditions in order to be eligible for depreciation: first, they must exceed a minimum cost limit (see chapter on depreciation methods). Secondly, they must help the business to generate income. Thirdly, their useful life must be more than one year. And finally, they must lose value over time due to wear and tear. Three types of assets meet these conditions:

• Depreciable, movable, material assets: this includes – among other things – operating equipment and systems that are connected to the ground permanently, as well as machines, tools, business equipment, IT systems and vehicles.

• Depreciable, immovable, material assets: this includes buildings – as well as independent parts of buildings – and outdoor facilities, such as road access, enclosures, courtyard fortifications or fences on a business's property. The land itself must be shown separately from the buildings and outdoor facilities it contains. This is because the land itself is not considered to be subject to wear and tear and therefore cannot be depreciated.

• Depreciable, intangible assets: these are all non-physical objects in the form of rights and values. This includes – among other things – business value, trademarks, patents or licences, manufacturing processes, copyrights, delivery and option rights, and even software. However, intangible assets may only be depreciated if they were purchased by the business and are evidently subject to a continuous loss of value. If these assets were created by the business itself, they may not be depreciated.

What is straight-line depreciation?

The most common depreciation method is straight-line depreciation. In this method, the asset is depreciated in regular annual increments (Section 1 of Article 7 of the EStG). Therefore, acquisition or production costs are distributed evenly over the useful life of the asset. For example, a refrigerator or sales counter bought by a business can be depreciated over a ten-year period. The annual depreciation will be 10% of the initial purchase value.

In the year of purchase, it is important to note that depreciation can only be carried out pro rata. In practice, this means that if the purchase was made in July, the business may only write off half of the annual depreciation amount. For example: on 1 July 2024, a business purchases a document shredder for €600. According to law, the useful life is assumed to be six years. This means that €100 may be depreciated each year. However, given that the shredder will only be used for six months in 2024, operating expenses can only be written off for six months. This means that the depreciation in 2024 would be €50, with a depreciation of €100 euro each year from 2025 to 2029. In 2030, the remaining €50 left over from the year of purchase shall be depreciated.

In principle, straight-line depreciation can be applied to all types of assets. In practice, it is common practice to use this type of depreciation for intangible assets or movable, material assets, as well as immovable, material assets, such as buildings. Aside from a few exceptions, an assumed useful life of 50 years applies. Annual depreciation therefore stands at 2% of the costs.

What is reducing balance depreciation?

The second potential depreciation method is reducing balance depreciation (Section 2 of Article 7 of the EStG). Reducing balance depreciation was introduced by the legislature for a limited time during the COVID-19 pandemic to provide businesses with financial support for new investments. It is limited to movable, material goods. The difference between reducing balance depreciation and straight-line depreciation lies in the annual amount due. When it comes to reducing balance depreciation, the annual amount is not always the same. Instead, it is calculated as a percentage of the residual book value of the previous year. This means that the amount is at its highest in the first year of depreciation and then decreases year on year. As a special arrangement, reducing balance depreciation initially applied exclusively to assets purchased or manufactured between 1 January 2020 and 31 December 2022. However, the Growth Opportunities Act saw reducing balance depreciation reintroduced for the period between 1 October 2023 and 31 December 2024.

Reducing balance depreciation is calculated in the year of purchase or manufacture at 2.5 times that of straight-line depreciation. However, the amount is capped at 25% of the asset's cost. In the previous example, the annual straight-line depreciation for the shredder was €100. When multiplied by 2.5, the contribution amount is €250. However, as the value can only be a maximum of 25% of the asset's cost, the first full annual amount is €150. In the second year of depreciation, the remaining amount – €450 – serves as the starting value. In the second year, 25% of €450 would result in a depreciation amount of €112.50.

Reducing balance depreciation can have its advantages. Among other things, it can reflect the decline in an asset's value more realistically than its straight-line counterpart. For example, vehicles, material goods and technical equipment generally experience a greater loss of value in their first few years of use. Reducing balance depreciation can therefore reflect this wear and tear more effectively. Furthermore, the higher annual amount in the early years can result in reduced taxable income. This could mean that businesses have to pay less tax overall.

Is it possible to change depreciation methods?

In principle, if a business has settled on straight-line depreciation for an asset, it is not possible to then switch to reducing balance depreciation. However, you can switch from reducing balance to straight-line depreciation at any time. In any case, to complete an asset's depreciation successfully, a straight-line depreciation must be carried out in the final year of depreciation at the latest. However, it may make financial sense for a business to switch from reducing balance to straight-line depreciation ahead of the final year.

What other forms of depreciation exist?

In addition to straight-line and reducing balance depreciation, there is also extraordinary depreciation. This can apply to movable and immovable assets in the event of extraordinary wear and tear. For example, it can be used in exceptional circumstances, such as flooding or fire, but also in the event of unforeseen changes in fashion and taste which have a direct impact on the asset.

When it comes to assets with a low purchase value or low manufacturing costs, low-value asset depreciation may apply. Movable assets with a value of up to €250 are written off immediately and as a one-off, rather than being spread over several years. For assets with a value of between €251 and €800, businesses can choose to write them off immediately or they can consider writing them off as a collective item. Assets can be combined into a collective item up to a value of €1,000.

Since 2021, businesses have had a choice when it comes to computer hardware and software: a business can either depreciate the hardware or software on a straight-line basis over three years or – as with low-value assets – write these off in full immediately in the year of purchase. The background for this is a new regulation that sets the useful life of PCs, notebooks, printers and computer programs to one year – as long as the devices or licences were purchased after 1 January 2021. The costs are immaterial and can be above the €800 limit that applies to writing off low-value goods immediately.

How is depreciation calculated?

Depreciation is calculated based on the depreciation tables provided by the German Federal Ministry of Finance. The depreciation tables outline the normal useful life of assets that are not used in a specific industry. The normal useful life is defined as the number of years over which the wear and tear or value reduction of an asset extends before it must normally be replaced or renewed. It also determines over how many years an asset is depreciated.

For example, a mobile phone is assumed to have a useful life of five years. A television, monitor or camera are assumed to have a useful life of seven years. The annual contribution for straight-line depreciation for one of these devices, assuming a purchase price of €1,000, is calculated by dividing this figure by 5 or 7. This would result in an annual straight-line depreciation of €200 or €142.85 respectively.

Normal useful life examples

Businesses must calculate the depreciation correctly, choose the best depreciation method and record everything accurately in their accounts. This plays a key role in allowing the business to take advantage of tax benefits and provides a realistic representation of the business's value. For further, detailed information on business accounting, visit the Stripe resources portal. If you would like to explore opportunities for professional support with your financial processes, please contact our Sales team.