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Sec 179 Expensing
Small Business Jobs Act (SBJA) Extends 179 Expensing and Reinstates Bonus Depreciation.
Plan now to maximize deductions for equipment purchases
The recently enacted Small Business Jobs Act of 2010 includes a wide-ranging assortment of tax changes generally affecting businesses. Two of the most significant changes allow for faster cost recovery of business property.
In order to help small businesses quickly recover the cost of certain capital expenses, small business taxpayers can elect to write off the cost of these expenses in the year of acquisition in lieu of recovering these costs over time through depreciation. Under pre-2010 Small Business Act law, taxpayers could expense up to $250,000 for qualifying property – generally, machinery, equipment and certain software – placed in service in tax years beginning in 2010. This annual expensing limit was reduced (but not below zero) by the amount by which the cost of qualifying property placed in service in tax years beginning in 2010 exceeded $800,000 (the investment ceiling).
Under the new law, for tax years beginning in 2010 and 2011, the $250,000 limit is increased to $500,000 and the investment ceiling to $2,000,000; this is retroactive to January 1, 2010. The new law also makes certain real property eligible for expensing. For property placed in service in any tax year beginning in 2010 or 2011, the up-to-$500,000 of property that can be expensed can include up to $250,000 of qualified real property (qualified leasehold improvement property, qualified restaurant property, and qualified retail improvement property).
Another major development from the passage of the SBJA was the reinstatement of the bonus depreciation rules. Pre-2010, Congress allowed businesses to more rapidly deduct capital expenditures of most new tangible personal property, and certain other new property, placed in service in 2008 or 2009, by permitting the first-year write-off of 50% of the cost. The SBJA extends the first-year 50% write-off to apply to qualifying property placed in service in 2010 (2011 for certain property).
With this news, we thought it was appropriate to provide you some additional information on the basics of depreciation and Sec. 179 of the Code and bonus depreciation.
Ordinarily when you buy equipment and other assets for your business, you’re required to depreciate the costs over several years for tax purposes. Sec. 179 allows you to “expense” in other words, deduct immediately as much as 100% of the cost of a qualified asset in the year you place it in service.
To qualify for depreciation or expensing, an asset must be “placed in service.” That means the asset is ready and available for use in your business – in other words, it’s operational and at the work site. But you don’t necessarily have to be using the asset. Backup equipment and replacement parts, for example, are placed in service when they’re available for use.
The Sec. 179 election is available for most equipment, “off-the-shelf” computer software, machinery, furniture and other tangible personal property purchased for use in an active trade or business.
As stated above, the amount you can expense under Sec. 179 is subject to an annual limit, which is phased out on a dollar-for-dollar basis when your total investment in Sec. 179 property exceeds the phase-out threshold. Under the SBJA, for 2010 the expensing limit has been increased to $500,000 and the phase-out threshold to $2,000,000. The $500,000 limit is reduced by $1 for every dollar of 2010 qualified purchases exceeding $2,000,000. So, for example, if you spend $2,100,000 on qualified property this year, the most you can expense, pursuant to Sec. 179, is $400,000.
Meeting the income limit
Sec. 179 limits expensing to a taxpayer’s taxable income from all sources, so you can’t use the election to generate a loss. If the taxable income limit prevents you from deducting all of your Sec. 179 expenses this year, you can carry over the unused deductions to future years. However, you may be better off forgoing some or all of the election this year and using ordinary depreciation deductions to generate a loss.
If you’re a sole proprietor for federal tax purposes, taxable income includes any wages you earn as an employee plus your spouse’s wages or self-employment income if you file a joint return. And you can carry over and deduct in future tax year’s expenses you’re unable to deduct because of the income limit.
Let’s say, for example, John invests $100,000 in equipment for a startup business. The company has no taxable income for the year, but John’s wife, Mary, has $110,000 in taxable income from her job. John and Mary can deduct the entire $100,000 investment on their tax return. (The rules are more complicated for pass-through entities, such as partnerships and S corporations.)
A tax rule of thumb generally advises that you should take as many deductions as possible this year and defer as much income as possible to later years. This may or may not be the case because of the possible expiration of the Bush tax cuts. Your individual situation should be assessed by your White, Nelson tax advisor prior to accelerating purchases into 2010.
Like all rules of thumb, there are exceptions. For example, if you anticipate being in a higher income tax bracket in future years, you may be better off holding off on asset purchases – even if it means you’ll be subject to lower Sec. 179 expensing limits. Why? Because deductions save more tax dollars when you’re paying tax at a higher rate. For example, a $10,000 deduction saves $2,800 in taxes if you’re being taxed at the 28% rate, but it saves $3,500 if you’re being taxed at the 35% rate. It is important to note that the increased 179 limits are for both 2010 and 2011 and therefore delaying a purchase subject to Sec. 179 may not be punitive.
Bonus depreciation is Back!
The SBJA reinstated bonus depreciation at 50% for both 2010. Bonus depreciation allows you to accelerate your depreciation deduction for a qualified asset by taking more of it for the year of purchase, in this case 50% of an eligible asset’s adjusted basis.
Bonus depreciation isn’t subject to any asset purchase limits, so businesses ineligible for Sec. 179 expensing can also take advantage of it. And businesses that qualify for Sec. 179 expensing can take bonus depreciation on asset purchases in excess of the $500,000 Sec. 179 limit. (Of course, they had to keep in mind the $2,000,000 Sec. 179 phase-out threshold.)
If you are a capital intensive business, bonus depreciation could save you considerable tax dollars. Your White, Nelson service advisor will be glad to help you ascertain the benefit from this deduction.
Getting the best result
To get the best tax result from your asset purchases and depreciation-related deductions, examine your overall tax situation with your White, Nelson tax advisor before year end, so you still have time to make asset purchases and benefit from the 2010 tax breaks if appropriate.
Don’t get caught in the recapture trap!
Be sure that property you expense under Section 179 is used more than 50% of the time for business. If business use drops below 50%, you’ll have to recapture a portion of the Section 179 deduction and pay taxes and interest on that amount. Penalties may apply. The recaptured amount is the excess amount you expensed minus the amount you would have deducted under regular depreciation rules.
If you have questions regarding this issue or would like to understand how these deduction allowances may apply to your business, please contact your White, Nelson & Co. tax professional or Paul Treinen, Tax Partner, at 714-978-1300.