Section 179 of the IRS Tax Code allows a business to elect to deduct the full cost of qualifying new or used purchased, financed or leased equipment placed in service during the current tax year within specified dollar limits. The election is made on Form 4562 of the original return for the tax year in which the purchases are made. This provides a potential advantage to businesses that would otherwise be required to depreciate such equipment over its recovery years.
The American Taxpayer Relief Act of 2012 (“ATRA”) raised the Section 179 dollar limits. For 2013, a business can deduct up to $500,000 of qualifying purchases (the dollar limitation) with an overall $2,000,000 limit on capital purchases (the investment limitation). The dollar limitation is reduced dollar for dollar by the amount of qualifying purchases in excess of the investment limitation. Therefore, the Section 179 deduction is completely phased out for businesses that make at least $2,500,000 of qualifying purchases. Furthermore, the election to expense the total cost of property for any tax year cannot exceed business taxable income, thereby creating a loss. The disallowed portion that is in excess of taxable income, however, can be carried forward to be used in future years.
Most equipment such as business machinery, office furniture, off-the-shelf software, computers and vehicles will qualify for Section 179 treatment (computers and vehicles, however, may be considered listed property subject to certain limitations that are beyond the scope of this discussion). The following is a list of non-qualifying property:
- Real property – this category consists of land, buildings, permanent structures, and the components of permanent structures such as improvements, paved parking lots and fences. However, ATRA also extended prior law that enabled taxpayers to expense under Section 179 certain qualified real property that includes certain leasehold improvement property, restaurant property, and retail improvement property
- Air conditioning and heating equipment
- Property that is –
- Used outside of the United States
- Used to furnish lodging
- Acquired by gift or inheritance
- Purchased from related parties
The rules that govern whether property or equipment should be considered personal or real can be complicated. Please contact your accountant or tax preparer to ensure that you are in compliance with the requirements of Section 179.
Besides increasing the dollar limits of Section 179, ATRA also reinstated Bonus Depreciation to 50%. Unlike Section 179, there is no investment limitation with respect to bonus depreciation. This allows businesses that exceed the $2,000,000 Section 179 cap to write-off 50% of qualified assets in the year of acquisition using Bonus Depreciation.
Also unlike Section 179, the bonus depreciation deduction is not limited to taxable income. For a corporation, if the bonus depreciation amount creates a net operating loss, it can be carried back or forward to previous or future income years, respectively. In the case of a sole proprietor or pass-through entity such as an LLC or S corporation, the loss can be offset against other income on your current year personal tax return.
However, Bonus Depreciation can only be taken on new property with a recovery period of 20 years or less, qualified leasehold improvements, certain computer software, and water utility property. Used equipment, as well as most software, does not qualify.
Timing of Purchases
Many business owners typically look for deductions as year-end approaches and equipment purchases may make perfect sense under this scenario. There are, however, some limitations. Under the regular depreciation rules, the half-year convention applies to equipment purchases. This means that no matter what month of the year you begin using the property, you must treat it as if you began its use in the middle of the year. So you will generally be limited to one-half of the first year’s depreciation, regardless of when you placed the property in service.
Further deduction constraints may apply if you place more than 40 percent of your total property for the year into service in the last quarter. In such instances, the mid-quarter convention rule will be triggered to further limit your regular depreciation deduction for all current year purchases.
There is good news, however. Neither Section 179, nor bonus depreciation are subject to either the half-year or mid-quarter convention rules. By using these provisions, a business can therefore maximize its deduction for yearend purchases.
Deduction and Depreciation Hierarchy
Write offs are typically maximized by first claiming Section 179, followed by Bonus Depreciation and then regular depreciation.
Both the Section 179 deduction and bonus depreciation are considered depreciation for recapture purposes. Therefore, a gain on disposition of such property within its recovery period will result in ordinary income recapture. As a result, any gain will first be taxed at ordinary income rates before any is subject to the more favorable capital gain rates.
ATRA extended the benefits of Section 179 and bonus depreciation through the end of 2013 by delaying the investment and dollar limitation reductions previously scheduled for Section 179, and by preventing the expiration of bonus depreciation altogether. There is no guarantee that Congress will do the same for 2014 and beyond.
Bear in mind that many states have not adopted the recent increased Section 179 limits, nor do they allow bonus deprecation. This could greatly reduce or eliminate the benefits of these provisions at the state level.
For more information on the Section 179 or another area of accounting, please contact Victor C. Belgiorno at 516-861-3704 or VBelgiorno@dsjcpa.com or Bob Jahelka at 516-861-3707 or BobJahelka@dsjcpa.com.