Tax Tips
Depreciation Expense - Section 179 - May 2000
Richard Scrivanich - Partner
With a little planning now, a small business can save some tax dollars by buying equipment. Under Section 179, the cost of tangible depreciable personal property may be deducted for the taxable year in which it is placed in service rather than depreciated under the regular depreciation rules of Section 168.
Section requirements
Tangible personal property is property that meets the definition in Section 1245(a)(3) (which includes most personal property) and is acquired by purchase for use in the conduct of an active trade or business. For 2000, the maximum amount allowed as a deduction is $20,000 (The deduction increases through a phase-in schedule until it reaches $25,000 in 2003). Any remaining cost after expensing is depreciated according to the normal applicable rules. (Limitations on the deduction under Section 179 are modified for enterprise zone businesses).
The allowable amount of $20,000 must be reduced by the excess of the cost of property placed in service during the taxable year that is above $200,000 i.e., once your total investment exceeds $200,000, the deduction is phased out dollar-for-dollar. This lost deduction is permanent, and it cannot be carried forward. The phase-out is intended to limit this expense deduction to smaller businesses; larger ones often place more than $200,000 worth of equipment in service in any given year.
The deduction is further limited to the amount of nontaxable income derived from the taxpayer's active trade or business. The nondeductible portion is carried forward indefinitely until it can be deducted.
Factors to consider
When looking at whether to use the Section 179 election, several factors should be considered. First, the individual's or business' tax bracket should be examined. If an individual is in a tax bracket higher than 15%, it is probably worth considering. Below 15%, it may be better for an individual not to take the deduction, especially if he or she expects to have higher income in the following years; the depreciation may be more valuable in later years to offset higher tax rates.
Second, consider the timing of the purchase of the property. If a business is going to purchase equipment over several years, consider spreading out the acquisitions so that they don't exceed the $200,000 limitation in any given year.
Third, consider the useful life of the asset. If some assets purchased have a five-year life and others have a seven-year life, it is better to take the Section 179 deduction on the longest-lived assets first.
Depreciation advantage
You can also use Section 179 to eliminate the mid-quarter rule under Section 168 from taking effect. Generally, under this rule, if more than 40% of tangible personal property that is placed in service throughout the year is placed in service during the last quarter, then Section 168(d)(3) will apply to all the property placed in service during the year and limit the depreciation otherwise available. But by using Section 179 on those assets that are acquired in the last quarter, you may be able to eliminate the mid-quarter convention from applying; it may reduce the basis of those assets below the 40% threshold.
If you have any tax related questions, please call me at (562) 698-9891.
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