From time to time, an owner of a small business will purchase equipment, office furnishings, vehicles, computer systems and other items for use in the business. How to deduct the cost for tax purposes is not always an easy decision because there are a number of options available, and the decision will depend upon whether a big deduction is needed for the acquisition year or more benefit can be obtained by deducting the expense over a number of years using depreciation. The following are the write-off options currently available.
- Depreciation – Depreciation is the normal accounting way of writing off business capital purchases by spreading the deduction of the cost over several years. The IRS regulations specify the number of years for the write-off based on established asset categories, and generally for small business purchases the categories include 3-, 5- or 7-year write-offs. The 5-year category includes autos, small trucks, computers, copiers, and certain technological and research equipment, while the 7-year category includes office fixtures, furniture and equipment.
- Material & Supply Expensing – IRS regulations allow certain materials and supplies that cost $200 or less, or that have a useful life of less than one year, to be expensed (deducted fully in one year) rather than depreciated.
- De Minimis Safe Harbor Expensing – IRS regulations also allow small businesses to expense up to $2,500 of equipment purchases. The limit applies per item or per invoice, providing a substantial leeway in expensing purchases. The $2,500 limit is increased to $5,000 for businesses that have an applicable financial statement, generally large businesses.
- Routine Maintenance – IRS regulations allow a deduction for expenditures used to keep a unit of property in operating condition where a business expects to perform the maintenance twice during the class life of the property. Class life is different than depreciable life.
- Unlimited Expensing – The Tax Cuts and Jobs Act passed in December 2017 ncludes a provision allowing 100% unlimited expensing of tangible business assets (except structures) acquired after September 27, 2017 and through 2022. Applies when a taxpayer first uses the asset (can be new or used property).
- Bonus Depreciation – The tax code provides for a first-year bonus depreciation that allows a business to deduct 50% of the cost of most new tangible property if it is placed in service during 2017. The remaining cost is deducted over the asset’s depreciable life. The 50% rate applies for new property placed in service prior to September 28, 2017 and, by election, to new or used property acquired and first put into use by the taxpayer after September 27, 2017 and before December 31, 2017.
- Sec 179 Expensing – Another option provided by the tax code is an expensing provision for small businesses that allows a certain amount of the cost of tangible equipment purchases to be expensed in the year the property is first placed into business service. This tax provision is commonly referred to as Sec. 179 expensing, named after the tax code section that sanctions it. The expensing is limited to an annual inflation-adjusted amount, which is $510,000 for 2017 and $1 million for 2018. To ensure that this provision is limited to small businesses, whenever a business has purchases of property eligible for Sec 179 treatment that exceeds the year’s investment limit ($2,030,000 for 2017 and $2.5 million for 2018), the annual expensing allowance is reduced by one dollar for each dollar the investment limit is exceeded.
An undesirable consequence of using Sec. 179 expensing occurs when the item is disposed of before the end of its normal depreciable life. In that case, the difference between normal depreciation and the Sec. 179 deduction is recaptured and added to income in the year of disposition.
- Mixing Methods – A mixture of Sec. 179 expensing, bonus depreciation and regular depreciation can be used on a specific item, allowing just about any amount of write-off for the year for that asset.
For some individual taxpayers, the alternative minimum tax (AMT) may be a concern. Bonus depreciation and Sec. 179 expensing are not preference items, and therefore their use will not trigger an AMT add-on tax. However, the difference between 200% MACRS depreciation, if claimed, and 150% MACRS depreciation is a preference item for AMT and could cause or add to the AMT tax.