How does depreciation affect the basis of an asset?

• A. Depreciation increases the basis
• B. Depreciation has no effect on basis
• C. Depreciation reduces the basis; basis equals cost plus capital improvements minus depreciation
• D. Depreciation only affects selling price

Answer: (C)

Depreciation reduces the basis because basis is what you’ve invested in the asset for tax purposes. You start with the asset’s cost, add any capital improvements, and subtract the depreciation you’ve claimed over time. This setup keeps pace with the fact that part of the asset’s value has already been recovered through deductions. When you sell, the gain or loss is the sale price minus this adjusted basis (cost plus improvements minus depreciation). So, claiming depreciation lowers the basis, which can increase the taxable gain on sale. It doesn’t increase the basis, and it isn’t correct to say it has no effect or that it only affects selling price.