06/ 05/ 2006
by Kay Bell
Any business owner knows all too well how much must be spent on equipment to run a successful company. And while such capital investments do provide some tax benefits, that means, in most cases, depreciating them so that their tax value is spread over the entire time the property is used in the business.
However, as with most tax areas, there is an exception. Section 179 of the tax code provides businesses a way to get immediate tax breaks on some capital purchases. And through the past few years, this tax-saving opportunity has been greatly enhanced.
A few ground rules
Assets claimed as a section 179 deduction, or 179 expensing as the write-off is commonly called, must be depreciable tangible personal property. This generally includes machinery, furniture, building fixtures and computer hardware and software. Real estate, however, doesn't count.
The equipment must be used primarily (more than 50 percent of the time) for a business purpose. You still can expense an item if you use it for both business and personal purposes, but the section 179 deduction then is limited to the business percentage of the item's cost.
Be careful, though, about who sells you the equipment. If you buy it from a relative or an entity in which you have a controlling interest, you can't expense it.
Do your recent or planned purchases meet these guidelines? Good.
Look at the numbers
You can deduct the equipment in the year in which you place it in service as long as it doesn't exceed two crucial thresholds: the annual dollar limit and the annual investment limitation.
Tax legislation in 2003 dramatically increased both these amounts. The Tax Increase Prevention and Reconciliation Act, which became law in May 2006, extends the more beneficial Section 179 expensing thresholds through 2009, thanks to pressure from NFIB.
In 2006, you can expense up to $108,000 in business equipment. So if you spent $100,000 on heavy machinery for your construction business and another $15,000 to upgrade your company's computer system, you can write off most of these costs on your return.
The $7,000 that exceeds the limit must be depreciated. When, as in this example, you exceed the limit, the choice of which equipment to expense or depreciate is yours. Generally, you should depreciate the property with the shorter recovery period, since you'll recoup those costs more quickly.
If your expenses don't reach the maximum dollar amount, no problem. You can expense as much (within the limit) or as little as you want, depending on your overall business and tax situations.
In instances where you have extraordinary expenses, however, your 179 write-off will be reduced. This is where the annual investment limitation comes into play.
For 2006, this amount is $430,000. So if you purchase $450,000 worth of equipment this year, you must reduce your 179 expensing amount by the $20,000 that you are over the investment limitation, meaning you can only immediately deduct $88,000 instead of $108,000.
And if your total capital expenditures this year exceed $535,000, you cannot take any 179 deduction.
Beware of potential pitfalls
Not all states have followed federal law changes through the last few years, so business expense and depreciation rules might be quite different on your state return. Be sure to keep records that will help you meet your more local tax rules as well as those of the IRS.
If you expense an item and then later sell the equipment or stop using it for more than 50 percent of the time in your business, you might have to recapture some of the federal deduction you originally claimed. So if you plan to use the equipment for only a short time, consider depreciating it instead to avoid this complicated recapture process.
And plan your purchases with an eye on the tax code to ensure you get full advantage of the generous 179 expensing option while you can. NFIB is working for a permanent extension of relief, but without additional congressional action, in 2010 the equipment purchase and investment limits will revert to their prior law levels of $25,000 in allowable expensing and $200,000 for the phaseout threshold.
