Normally, it take several years to write off, or “depreciate” the cost of property such as equipment that your business has placed in service during the year. But business owners have a secret weapon at their disposal. By making a special tax return election, authorized by Section 179 of the tax code, you can frequently deduct all or most of the cost of qualified property that you acquire during the year.
Yet there are certain restrictions on the Section 179 deduction a business operation may claim. Significantly, you must contend with an annual limit on the maximum deduction amount. What’s more, this maximum write-off will be reduced by more than $100,000 in 2013 if Congress doesn’t amend the law before next year.
A quick review: Any business—including corporations, partnerships, and self-employed operations—can choose to currently deduct the cost of qualified business property placed in service during the year. For this purpose, “qualified business property” includes most types of tangible personal property. (Special rules apply to vehicles.) The property may be either new or used.
Prior to 2008, the maximum Section 179 deduction was gradually increased from $25,000 to $125,000. But then legislation doubled the maximum allowance to $250,000 and then again to $500,000, in addition to authorizing “bonus depreciation” deductions for qualified business property. A business could sometimes claim both the Section 179 deduction and bonus depreciation deductions for the same assets.
Subsequently, the maximum $250,000 Section 179 deduction was extended, but then was scheduled to be halved to $125,000 (which would have resulted in an inflation-indexed figure of $139,000 for 2012.) Now new legislation has extended the $500,000 maximum for two years through 2013, retroactive to the 2012 tax year. That will give many business owners plenty of tax incentive to place assets in service to benefit from the higher current write-off.
Be mindful that there are two other important considerations:
1. Annual income limit. The Section 179 deduction can’t exceed the net taxable income from your business activities. For example, if you own a small business producing $100,000 a year in net taxable income and you acquire $125,000 of qualified business property this year, your Section 179 deduction for 2012 is limited to $100,000. If you operate several businesses, the limit applies to the net taxable income from all of your business activities—not just one particular business.
2. Annual dollar threshold. If the total cost of property placed in service during the year exceeds an annual threshold, the maximum Section 179 deduction is reduced on a dollar-for-dollar basis. This dollar threshold has been adjusted by legislation along with the maximum Section 179 allowance. Currently, the reduction begins if the cost of qualified business property exceeds $2 million, a lofty figure for most small businesses.
Generally, the optimal strategy for 2013 will be to pile on more equipment purchases to take advantage of the half-million deduction. But that’s not always the best idea. For instance, if you expect 2013 to be a low-income year for various reasons and you anticipate that your tax liability will be much higher in 2014, you might either bypass the Section 179 deduction this year or postpone the acquisition of qualified business property to next year when the Section 179 deduction will be more valuable to you.
Finally, note that the Section 179 deduction can still be combined with 50% bonus depreciation deduction for 2013. Unlike the Section 179 deduction, bonus depreciation is available only for new, not used, property that otherwise qualifies under the law. If any amount remains after the Section 179 deduction and the bonus depreciation deduction are claimed, it can be written off under the regular depreciation rules. Bonus depreciation is scheduled to vanish after this year.
The practical approach now is to sit down with your tax advisor to assess your current situation. Then you can develop a plan for 2013 based on your personal circumstances.