In my tax return analysis workshops I ask the lenders for common adjustments to get them from taxable income to recurring cashflow to pay debts. The first one mentioned – and the loudest – depreciation. (Loudest because everyone is confident of that answer.)
Wrong! At least some of the time.
First, why oh why do we ever add it back?
We add back depreciation because it is a bookkeeping entry, a write-off of tangible items. Ditto for amortization, writing off intangible items like covenant not to compete, customer list, license or patent. And again for depletion, writing off natural resources like coal.
The real rule: Only add back depreciation when it has been subtracted from your starting number. Depreciation on the Schedule M-1, for example, has not been subtracted from taxable income of a corporation, partnership, LLC or s corporation. When you spot it, leave it alone.
