I do NOT understand depreciation. Can somebody help me? I need it explained like a 5 year old.

[longship]

26. This is a pretty good description

It can get much more complicated, as the rules have been tweaked significantly.

The general idea is that a company builds, say a building on a property. The property's value isn't going to change. But the capital investment of the building is subject to a diminished value as it ages. There are all sorts of esoteric IRS rules for coming up with the lifetime of the "asset". The bottom line is that your capital investment in building on the property can be deducted from your income, but only to the extent of its current value, which putatively decreases with age.

The IRS has very specific rules for a variety of classes of such "capitalized" property. E. G., computer equipment for years is entirely deductible, 100% depreciation, for many years. But buildings have a long lifetime, so it would be incorrect to allow a company to deduct the cost of construction of the building, since it would have substantial value even if the company went broke. (Possibly except if the building was in Detroit, but that's another problem.)

I hope this helps.