Depreciation is a vital tool that helps small businesses take significant deductions to lower tax bills. Depreciation refers to the diminishing value of an asset like real estate, vehicles, and office equipment.
There are many related factors to this deduction category, with the Section 179 deduction being one of the most helpful ones. This perk is named after internal revenue code section 179 and it allows businesses to deduct the entire cost of specific purchases up to $1 million.
Section 179 is often confused with bonus depreciation. Bonus depreciation is also referred to as Section 168k expensing and it enables owners to deduct up to 100% of the cost of the new asset. These two concepts might seem identical, but bonus depreciation comes after Section 179, doesn’t have income limits and has different qualifying property standards.
Basic Section 179 facts
Section 179 enables businesses to reduce gross income by deducting the entire cost of qualifying property and new equipment up to $1,000,000 per year in 2019. Keep in mind that this deduction only applies to the year in which the property was placed in service. This deduction had smaller depreciation limits like $500,000 in the past, but the 2017 Tax Cut and Jobs Act increased it to $1,000,000 per year. It’s important to note that many limits including these along with retirement account contributions are constantly changing and are indexed to inflation. Therefore, it’s wise to stay aware of any annual updates.
Section 179 also applies to purchased or financed equipment. The full purchase price is deductible in the year of service, regardless of being financed or owned outright. This is a very powerful concept as it can potentially make the tax savings larger than the lease payments.
In addition, Section179.org offers bonus cash payments to businesses who implement this deduction. One example has been an additional $179 per $10,000 financed which gives businesses three main benefits which are immediate equipment use, significant tax deductions, and cash bonuses. This rule can also apply to used equipment as well as new equipment. However, it doesn’t apply to personal equipment that has been converted to business use.
Vehicles can be subject to Section 179, provided that a business uses them for at least 50% for business use. A good way to accurately prove this is to use an app like Mile IQ to track business miles. Mile IQ lets self-employed individuals and business owners seamlessly switch between business and personal miles with the press of a button. On top of that, it automatically calculates mileage deductions for a variety of situations by multiplying the IRS mileage limits per category by total business miles.
Best situations for the Section 179 deduction
Section 179 can be seen as an immediate tax deduction in comparison to MACRS or Straight line depreciation methods. These methods spread either front-loaded deductions over time (MACRS) or the same annual deduction over the course of its useful life (Straight Line). Section 179 is useful in certain circumstances, and other methods like the straight line, MACRS, or bonus depreciation make sense in others. Businesses should use Section 179 if:
- They want simple bookkeeping.
- Depreciation can be very tricky, especially MACRS. There are many moving parts, which makes it easy to make mistakes and create accounting headaches. Therefore, section 179 can be used to simplify bookkeeping as they can just record the business expense in one year.
- They have a high tax bracket.
- This rule provides substantial tax deductions as it allows businesses to expense up to $1,000,000 per year for qualifying assets. Businesses that have a high tax bracket can take advantage of higher savings with this rule.
- They are startups.
- Many firms that are just starting out purchase vital equipment in the first year. Some examples of necessary equipment include office equipment, computers, software and attachments to a building like refrigerators. Each asset can be used to lower taxable income in this first year.
Section 179 has many advantages, but it’s important to consider two main altering factors which are if the property cost is greater than $2.5 million and if the business owner is married. The $2.5 million cap is referred to as the investment limit and the deduction is phased out after this amount. Business owners that file married filing joint or separate should have an agreement with their spouses on how to divide this deduction. Absent any agreement, this deduction is split 50/50% on each tax return.
Use IRS publication 946 and possibly a tax professional to gain more detail into all types of depreciation along with section 179 expensing. This publication also helps businesses choose the correct forms for each tax situation like using IRS form 4562 to record depreciation as well as elect section 179 treatment.
Section 179 vs. Bonus Depreciation
Bonus depreciation is very similar to section 179 as both codes enable businesses to deduct the full cost of qualifying equipment in the year in service. However, the main differences are the deduction limits, timing, and qualifying property. This might seem confusing, but the below comparisons will clarify it.
- This rule currently has no income, investment, nor deduction limits. However, the vehicle limit is $18,000. Since it doesn’t have an income limit, it can exceed business income resulting in a net operating loss or NOL. NOLs can be used to reduce future years’ taxable income (i.e NOL carryforward) or applied to prior years taxable income (i,.e NOL carryback). NOLs can be used for up to 20 years, and are canceled after that cutoff.
- Bonus depreciation is used after section 179 expensing. So, if a business purchases $1,100,000 of qualifying property, it can use section 179 to deduct the first million. From there, it can deduct 100% of the remaining $100,000. In the past, businesses could deduct only 50% of the remaining expense, but the Trump Administration raised it to 100%. The total tax savings would be $1,100,000 multiplied by the tax rate. So, a business with a combined tax rate of 25% would have a total tax deduction of $275,000.
- Qualified property types
- Tangible property with a useful life under 20 years, computer software, office equipment, livestock, fruit/nut bearing plants, specific improvements to the inside of the commercial property and non-commercial aircraft. Useful life refers to the amount of time an asset is expected to be used prior to becoming obsolete. This figure is used to calculate straight-line depreciation and is referred to as the recovery period if using MACRS. Specific property types under MACRS have predefined recovery periods like rental residential real estate’s being 27.5.
- This rule currently has a deduction limit of $1,000,000, an investment limit of $2,500,000 and can’t exceed business income. However, the vehicle limit is $10,000 and it offers a higher limit for heavier vehicles like SUVs at $25,000. Unlike bonus depreciation, it can’t generate an NOL.
- Qualified property types
- It applies to any tangible property regardless of its useful life. Like bonus depreciation, it also applies to computer software, office equipment, and livestock. Other qualifying assets include interior property improvements like check out counters, portable air conditioners, and storage tanks.
Common Section 179 mistakes to avoid
When to use which depreciation strategy or just section 179 can be confusing. Therefore, it makes sense to know which mistakes to avoid.
Not factoring in the depreciation recapture
Depreciation is a great tool for saving money on taxes, but what happens when a depreciable asset is sold? Then, businesses must always factor in depreciation recapture, which is the government’s way of getting money from depreciation deductions. Recapture occurs if the proceeds are higher than an asset’s cost basis and are taxed at ordinary income rates, not lower capital gains rates. This concept can greatly increase taxes and complicate tax situations.
One simple way to potentially avoid recapture is through a 1031 exchange. This only applies to real property and occurs when the sales proceeds are reinvested into a “like kind” asset. These reinvested proceeds would be tax exempt and not subject to recapture. A 1035 exchange is similar to a 1031 but applies to annuities and life insurance contracts. Businesses and individuals can exchange annuities, life insurance contracts, life insurance for an annuity, but not an annuity for life insurance.
Section 179 recapture
Recapture also applies to Section 179 assets and happens when a business adds income to a section 179 deduction taken in the prior year. This occurs when a property that was section 179 expensed was used for mostly personal reasons after being placed in service. Therefore, businesses would have to recapture part of the deduction that was taken and this can happen during any tax period the useful life.
It’s relatively simple to calculate this recapture. Start by subtracting the depreciation that would have been allowable via the section 179 for prior tax years and the tax year of recapture from the section 179 deduction claimed. A simple way to avoid recapture is to ensure that your asset will be used for at least 50% of business purposes. One common example that demonstrates how a business vehicle can have a higher personal use is when owners let a spouse or children drive a business use vehicle. If they use it too frequently for personal use, this could trigger Section 179 recapture.
Section 179 and Real Property
It’s important to note that real property like land, buildings, and other exterior assets like fences or parking areas don’t qualify for Section 179 expensing. Instead, businesses can use MACRS for rental property and must know that land isn’t depreciable. Also, any property that is inherited, used outside the US and purchased from related parties doesn’t qualify for Section 179 expensing. Conversely, types of property like interior improvements such as moving walls and refrigerators qualify for this deduction.
Section 179 and bonus depreciation can be great tools to save on taxes in the current year an asset is placed in service. If the asset was previously used for personal use and has been converted to business use, it won’t qualify. If a business thinks it’s income will dramatically increase over time, straight line or MACRS depreciation could be a good fit. This is because both methods apply tax deductions over the long term, not just a year. Lastly, most businesses use straight-line depreciation as it’s simpler than MACRS.
Section 179 resources
- Section 179.org: This useful resource goes into detail regarding section 179 and any annual updates. It also provides businesses the option to speak with tax experts and financing packages to take advantage of special cash bonuses. This site also includes a detailed section 179 calculator that helps businesses calculate their tax savings. The calculator accounts for certain fields like bonus depreciation, tax brackets, and cash savings on the purchase.
- Mile IQ: Tracking business miles is not only important for proving business use of automobiles, but it’s also an important deduction in and of itself. Thus, it’s very important to accurately track and calculate business miles. Mile deductions vary based on tasks like medical, moving or charitable purposes. There are some limitations to business miles which include not using the standard business mileage rate for more than four cars. Businesses can’t use this rate for a vehicle they’ve already used MACRS depreciation or section 179 expensing on.
- IRS pub 946 and the 2017 Tax and Jobs Act: This all-encompassing publication can help businesses with depreciation schedules, correct forms, specific tables, section 179 rules, and bonus depreciation standards. It’s wise to use this as a starting point and the 2017 Tax and Jobs act also influenced this schedule, The Trump administration significantly altered tax and estate planning regulations, which is why it’s prudent to know the fundamental shifts.
The tax code offers many tools like MACRS, straight line, bonus depreciation along with section 179 expensing that help businesses save on taxes. Depreciation reflects an asset’s reduction in value over time and spreads out the tax deductions accordingly.
Conversely, both bonus depreciation and section 179 allow businesses to deduct qualifying property in that year. This subject can seem daunting, but knowing the fundamentals of each code, proper uses, resources, and mistakes to avoid will help any business grow.
Disclaimer: This article isn’t tax law advice, but general education. Please consult a CPA or tax adviser for tax advice.