What is amortization? Most people have heard the word, but many don't know what it is. Basically, amortization is depreciation of intangible assets. But let's break this down a little bit more by using an example.
Let's say you buy an established restaurant for $200,000. For that amount you get the equipment, the furnishings, the decor, the dishes, the name, the clientele, the recipes, and the reputation. The equipment, furniture, d?cor, and dishes are called tangible. They are things you can physically touch and have specific value. These things are depreciated on your tax return, which means you deduct the cost of these items a little bit each year, usually for 3 to 7 years.
But what about the rest of the stuff you paid for - the name, the clients, the recipes, and the reputation? These items are intangible, so they are amortized. But how do you know the value of these items? The amortization value on these items is the difference between the value of depreciable items and what you purchased the business for. This amount will be deducted a little each year usually for 15 to 20 years. Why so long?
Well, things like equipment and furniture need to be replaced usually every 3 to 7 years, so most businesses have continuing deductions over the years as they upgrade and replace them. The things that qualify for amortization are onetime purchases, so the IRS feels that it should be stretched out over more years.
Amortization can be complicated and confusing and usually your tax preparer can help you. But it is important to have enough of an understanding to be able to give your tax preparer the right information.
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