Section 179 is the part of the tax code dealing with the depreciation of newly purchased capital equipment. Business owners have the choice of deducting part or all of the cost of this equipment in the year it is placed into service. How much of this up-front depreciation to use immediately is totally up to the owner within the boundaries of tax law. However, the amount to deduct for maximum advantage depends on many factors, including current year profits, projected future profits, predicted growth and desired cash flow.
Suppose you purchase a new full sized X-ray machine for $100,000 and place it into service on March 1st. Most medical equipment is depreciated over five years in the tax code, regardless of how long it actually lasts. The common way to depreciate this item is with the MACRS method over five years, starting with one-half year’s deduction the first year. For tax purposes you say the equipment was placed into service on July 1st. You deduct $20,000 the first year, $32,000 the second year, then smaller amounts in succeeding years until it is completely depreciated on June 30th of the sixth year. This gives you a predictable deduction for this item in future years.
But there may be situations where it is to your advantage to write off more than $20,000 of this cost immediately. First, suppose that you have had record sales this year and would like to reduce your tax liability as much as possible right now. Next, if you had a larger deduction and lower tax bill for this year, you may be in a position to buy more equipment, add more employees or otherwise expand your business. In such cases you may deduct any of all of the full $100,000 cost this year as a Section 179 deduction.
One tradeoff is that whatever you deduct this year will reduce the deduction for this item for the following five years. Another might occur if you dispose of the equipment before the end of the five-year depreciation period. If you took five years depreciation up front and then used the equipment for less than that, you in effect took too much depreciation. In that case the depreciation you deducted but never used is added back as income in the year you dispose of the property. In tax language this is called a “recovery”, and accounting for it can be complicated and costly. Consideration of how long you intend to use the equipment is therefore an important factor in deciding whether or not to use Section 179.
There is an overall limit of $500,000 to how much property can be deducted each year using Section 179. Many business owners choose to take the full deduction for their new equipment and then use the savings to buy new equipment, thus stimulating the economy. The dollar amounts and phase-out limits built into Section 179 make it especially attractive to small and medium size businesses.
The total cost of the equipment will eventually be written off regardless of which method you use. At that point the basis in the equipment is reduced to zero. Proper planning to understand Section 179 and distribute all your equipment cost deductions wisely can help save money and stimulate your business during the lifetime of the equipment.
Section 179 now allows eligible companies to deduct the cost of equipment immediately, rather than over several years. In 2013, you can deduct up to $500,000 for qualified purchases. Unless it is extended, the deduction amount is set to revert to $25,000 in 2014; which is what it was before the Jobs Act.Click to learn more about IRS section 179