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Typically, if property for business has a
useful life of more than one year, the cost
must be spread across several tax years as
depreciation with a portion of the cost
deducted each year.
But
there is a way to immediately receive these
income tax benefits in one tax year. The
provisions of Internal Revenue Code Section
179 allow a sole proprietor, partnership or
corporation to fully expense tangible
property in the year it is purchased.
And
tax-law changes over the past few years have
made this option much more appealing by
dramatically increasing the amount that can
be written off immediately. Changes first
made in 2003 and then extended in 2006, mean
that businesses can write off more of their
capital expenditures through 2009.
Enhanced section 179 expensing now is at the
base level of $100,000 with that level
indexed for inflation for the last several
years. This is four times more than the
previous-law limit of $25,000. In addition,
the investment limitation also has been
increased to more than $400,000 and it, too,
is indexed for inflation.
These changes mean that in 2006, a business
can expense $108,000 in capital expenditures
up to an overall investment limit of
$430,000.
Eligible Property
Property that may be written off in the tax
year of purchase, rather than depreciated
over the asset's useful life, includes :
Also, the definition of eligible section 179
property was expanded by the 2003
legislative changes to include off-the-shelf
computer software. Previously, it had to be
written off over three years. The IRS says
ineligible property includes:
-
Buildings and
their structural components
-
Income-producing
property (investment or rental property)
-
Property held by
an estate or trust
-
Property acquired
by gift or inheritance
-
Property used in a
passive activity
-
Property purchased
from related parties
-
Property used
outside of the United States
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How, When to Use Deduction
The
Section 179 election is made on an
item-by-item basis for eligible property.
You don't have to use it on all eligible
property bought in that year. The election
must be made in the tax year the property is
first placed in service.
The
Section 179 deduction isn't automatic.
Taxpayers who want to take the deduction
must elect to do so. You make the election
by taking your deduction on
Form 4562.
When you file this form, attach it to either
of the following:
-
Your original tax
return filed for the tax year the
property was placed in service,
regardless of whether you file it
timely.
-
An amended return
filed by the due date, including
extensions, for your return for the tax
year the property was placed in service.
Make sure you make the election when you
file your original income tax return for
that year. You can't later amend your return
to elect Section 179. The only exception to
this is if you amend your return before the
actual due date, including extensions, of
your original return.
For
example, the maximum extended due date to
file your return is Oct. 15. You file your
return on Sept. 1 and then realize you
didn't utilize the Section 179 deduction.
You still have until the Oct. 15 deadline to
file an amended tax return to claim the
deduction.
Laws tweaked to enhance Section 179
deduction
Congress periodically reviews the amount a
taxpayer can claim as the annual Section 179
amount. As part of an economic stimulus and
tax-reduction package signed into law in May
2003, the expense limit was temporarily
hiked from $25,000 to $100,000.
The
Tax Tax Increase Prevention and
Reconciliation Act (TIPRA), signed into law
on May 17, 2006, expanded this increase
through 2009. And an inflation adjustment
component means that the $100,000 will
increase while TIPRA is in effect.
Lawmakers upped and subsequently extended
the section 179 deduction amount in the
hopes it would encourage businesses to
invest in new equipment sooner.
However, when it comes to vehicles purchased
utilizing the Section 179 break, legislators
took back some of the benefit as it related
to large
sport utility vehicles.
When the limit was originally increased,
business owners were allowed to select for
company use one of several light-truck
models (which included many luxury SUVs)
weighing more than 6,000 pounds fully loaded
and write off most, if not all, of the costs
on their tax returns. That changed on Oct.
22, 2004, when the American Jobs Creation
Act became law; now only company vehicles
weighing 14,000 or more are eligible for the
larger deduction amount.
Any
amount of property over the maximum
deduction must be depreciated.
Limitation on annual amount of property
purchased
There also is a limit on the annual total of
deductible property. If the cost of
qualifying Section 179 property you put into
service in a single tax year now exceeds a
statutory base of $400,000 then you can't
take the full deduction.
This amount also is indexed for inflation
and runs through 2009.
For
2006, every dollar above $430,000 (the
inflation-adjusted limitation) that a
business owner spends on eligible property,
he loses a dollar in deductions.
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For
example, a manufacturer completely re-equips
his facility this year at a cost of
$437,000. This is $7,000 more than allowed,
so he must reduce his eligible deductible
limit to $101,000: the current $108,000
expensing limit minus $7,000.
Deduction limited to taxable income You have
now determined the maximum deduction based
on the amount of property purchased during
the year. You now must pass the aggregate
income hurdle.
Your deduction is limited to your aggregate
taxable income from the active conduct of
any trade or business. Active trade or
business includes employee and spouse's
wages, sole proprietorships, partnerships
and S corporations. Basically, this means
that unless you have other sources of
business income, your Section 179 deduction
can't create a taxable loss for your
business.
More business owners are able to take
advantage of the deduction when they combine
their company earnings with those of a
spouse or money earned in addition to (or
before starting) their own company income.
For
example, you are someone else's employee for
most of the year. Your wages exceed the
Section 179 deduction. You start your own
business at the end of the year and purchase
equipment and furniture. Even if your new
business doesn't generate gross income that
year, you can still take the Section 179
deduction on the new equipment and
furniture. Why? Your wages exceed the
Section 179 deduction.
This aspect of inclusion also applies to a
spouse. For example, you earn annual wages
of $60,000 as an employee. Your spouse
doesn't work during the year but begins a
new business at the end of the year. Your
spouse purchases and places in service
$15,000 of Section 179 property at the end
of the year. Your spouse's business doesn't
generate gross income at the end of the
year. Even though your spouse hasn't earned
trade or business income for the year, the
Section 179 deduction of $15,000 is still
allowed in full since your wages count as
trade or business income.
Any
amounts disallowed by the trade or business
taxable income limit are carried over to the
next year and added to the cost of any
eligible property placed in service in that
year. The same rules for maximum deduction,
maximum annual investment and taxable income
apply to the next tax year as well.
Under
Section 179 Expensing Allowance of the IRS
Code – allows for Bonus Depreciation on
equipment placed in service with an
obligation to purchase it prior to December
31, 2004.
In year 2004
and 2005 the Equipment Allowance is
$100,000, in 2006 the allowance will revert
back to $25,000.
Under the
“Jobs and Growth Reconciliation Act of 2003”
the first year depreciation bonus was
increased to 50% for equipment purchases and
qualified leasehold improvements made by the
taxpayer after May 5, 2005
The
following outlines (3) three different tax
benefit scenarios for a $200,000 equipment
purchase for the year specified.
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|
This table is only an example.
Please consult an accountant to
maximize your actual tax
benefit. |
2004
Tax Benefits
IRS Sec.-179
& 50% Bonus |
2005
Tax Benefits
IRS Sec.-179
|
2006
Tax Benefits
IRS Sec.-179
|
|
*Numbers are adjusted for
inflation |
Year 1 – Tax Benefits |
Year 1 – Tax Benefits |
Year 1 – Tax Benefits |
|
Equipment Cost |
$200,000 |
$200,000 |
$200,000 |
|
IRS Sec. 179 |
$102,000* |
$104,000* |
$25,000* |
|
Adjusted Basis |
$98,000 |
$96,000 |
$175,000 |
|
1st Year Bonus
Depreciation |
$49,000 |
N/A |
N/A |
|
Adjusted Basis |
$49,000 |
$96,000 |
$175,000 |
|
1st Year Percentage
of 5 Year Depreciation |
20.00% |
20.00% |
20.00% |
|
Depreciation |
$9,800 |
$19,200 |
$35,000 |
|
Total 1st Year
Write-off |
$160,800 |
$123,200 |
$60,000 |
|
Tax ($) Benefits Estimate tax
bracket: 35% |
$56,280 |
$43,120 |
$21,000
|
|
Equipment Cost After Year 1 Tax
Benefit |
$143,720 |
$156,880
LOST SAVINGS:
$13,160 |
$179,000
LOST SAVINGS:
$35,280 |
The
tax tip explains the process for using
Section 179 to fully expense certain
business expenses immediately instead of
depreciating them across a period of several
years. You should also be aware of less
obvious advantages of the Section 179
deduction:
-
Lowers adjusted
gross income, which could help you
qualify for various deductions which are
limited by AGI.
-
Lowers earned
income, which can increase your earned
income credit.
-
Is allowed in full
even if the eligible property is placed
in service on the last day of the year.
This tip also includes examples that
demonstrate the three limits: the maximum
dollar limit, the investment limit, and the
taxable income limit. By including
employment and spousal wages, many taxpayers
find they are able to take advantage of this
provision.
Are
you interested in more information? Refer to
Chapter Two of
IRS Publication 946: How To Depreciate
Property.
--
Updated May 30, 2006
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