The recent Small Business Jobs Act of 2010 extended two provisions that help business owners deduct asset purchases faster. The first provision allows 50% bonus depreciation on new assets purchased and placed in service during 2010 (this provision had expired December 31, 2009). The second provision increases the Section 179 expense allowance to $500,000. Section 179 is an election that can be made to immediately deduct the cost of certain assets.
What’s So Great about 50% Bonus Depreciation?
Bonus depreciation allows you to deduct the purchase price of certain assets much faster than if you had to follow the normal depreciation schedules. Under bonus depreciation, you can immediately deduct 50% of the cost of eligible property. The remaining purchase price is depreciated over the asset’s useful life.
Example: You buy $100,000 of eligible property (defined below) during 2010. The annual depreciation under regular depreciation and bonus depreciation (assuming it’s 5 year property) is shown in the following table:
|
Year
|
Regular Depreciation
|
Bonus Depreciation
|
|
1
|
$20,000
|
$60,000*
|
|
2
|
$32,000
|
$16,000
|
|
3
|
$19,200
|
$9,600
|
|
4
|
$14,400
|
$7,200
|
|
5
|
$14,400
|
$7,200
|
|
Total
|
$100,000
|
$100,000
|
* The $60,000 is composed of 50% bonus depreciation ($50,000) plus regular depreciation on the remaining purchase price of $50,000 ($10,000).
What is Eligible Property for Bonus Depreciation?
Eligible property includes:
- tangible personal property with a recovery period of 20 years or less (which is pretty broad)
- it is placed in service before January 1, 2011
- certain long-period-production property and certain transportation property may be placed in service before January 1, 2012)
- its ORIGINAL use must begin with the taxpayer (i.e., it is new and not used property)
Even though bonus depreciation only applies to new property, it may apply to reconditioned property.
Example: John buys a $15,000 used machine and reconditions it for $10,000. The $15,000 purchase price for the used equipment is not eligible for bonus depreciation, but the $10,000 for reconditioning is eligible for bonus depreciation.
A safe harbor provides that property containing used parts is not treated as used if the cost of the used parts does not exceed 20% of its total cost. In other words, for example, if a taxpayer buys a machine consisting of 80% new parts and 20% used parts is treated as having bought a new machine whose total cost is eligible for bonus depreciation.
New property initially used by the taxpayer for personal use and then converted to business use meets the original use requirement.
Example: Sara bought a new pickup truck that she used personally. Later, she started a business and began using the pickup exclusively in her business. The pickup is eligible for bonus depreciation as original use property because its use began with Sara, even though the original use was not business use. The amount eligible for regular and bonus depreciation is the lower of market value or original purchase price when she starts to use the pickup in her business.
Section 179 and You
Under Section 179, a taxpayer can elect to deduct as an expense in the year of purchase up to a specified amount of the cost of new or used tangible personal property. The remainder of the purchase cost is depreciated over the asset’s useful life. For tax years beginning in 2010 and 2011, the dollar limitation on the expense deduction is $500,000. The amount was $250,000 for 2010 before the law change. The Section 179 expense allowance is reduced dollar for dollar when the cost of property placed in service for the year exceeds $2 million.
Example: ABC Corp buys machinery and equipment for $2.1 million. Since the property placed in service exceeds the limit by $100,000, the allowable Section 179 expense is reduced by $100,000 to $400,000.
The Section 179 expense is limited to taxable income from any of the taxpayer’s trades or businesses. If the taxpayer operates under an S corporation or LLC, Section 179 is also subject to the taxable income of the S corporation or LLC. However, when determining the taxable income of an S corporation or LLC, shareholder wages (for an S corporation) or guaranteed payments (for an LLC) are added back to the business’ taxable income. Section 179 disallowed because of the taxable income limitation can be carried forward indefinitely.
Example: S Corp has $100,000 of taxable income before Section 179 expense. If S Corp buys $150,000 of equipment, its Section 179 expense is limited to its taxable income of $100,000.
Example 2: Same as above example except that the $100,000 taxable income is after a $60,000 deduction for shareholder wages. Since shareholder wages are added back to taxable income for Section 179 purposes, the adjusted taxable income is $160,000 and the S corp can claim the full $150,000 Section 179 deduction.
Example 3: NEW SET OF FACTS: Joan operates as a proprietorship and files a Schedule C (Profit or Loss from Business). She has $2,000 of taxable income from the business and bought $5,000 of equipment. Her husband has wages of $50,000. Even though her proprietorship only has $2,000 of taxable income, she can claim the full $5,000 Section 179 expense because her husband’s $50,000 wages count as taxable income from a trade or business for Section 179 purposes.
If a business can immediately deduct 100% of the purchase price under Section 179 up to $500,000, when would 50% bonus depreciation ever be advantageous? Bonus depreciation would be advantageous if the taxable income limitation prevents the taxpayer from using the full Section 179 deduction. Bonus depreciation is also helpful if the taxpayer has already used the full $500,000 Section 179 for the year and has bought additional assets for which it can claim bonus depreciation. Bonus depreciation can also be used to create a loss in the business which can be carried back to prior years to obtain an immediate refund. Section 179 is limited to taxable income for the year and thus cannot be used to create a business loss that can be carried back.
Buzzkill Disclaimer: This post contains general tax information that may or may not apply in your specific tax situation. Please consult a tax professional before relying on any information contained in this post.
Any tax advice contained in the body of this post was not intended or written to be used, and cannot be used, by the recipient for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code or applicable state or local tax law provisions. Any information contained in this post does not fall under the guidelines of IRS Circular 230.
Any tax advice contained in the body of this post was not intended or written to be used, and cannot be used, by the recipient for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code or applicable state or local tax law provisions. Any information contained in this post does not fall under the guidelines of IRS Circular 230.