Over the years many companies have saved on their taxes by taking advantage of Section 179 and Section 168(k) of the IRS Tax Code. While originally adopted in 1958, there have been a great many modifications to the provisions, including some fairly significant changes in 2018.
For 2020, there were slight increases in the deduction limit and the spending cap. Additionally, the CARES Act made changes to the treatment of Qualified Improvement Property (QIP) providing opportunities to carry losses back to previous years and obtain refunds, as well as restoring the 5-year carryback provision for non-operating losses (NOL) which applies to years 2018, 2019 and 2020.
Herein we’ve provided some information about opportunity for tax savings and things to consider when taking advantage of the tax benefits.
What is Section 179?
In short, Section 179 allows eligible businesses to deduct the full purchase price of qualifying equipment in the year it was put into service. This creates a larger initial expense deduction than using a standard depreciation method, thus reducing the tax burden for the company.
While there are some limitations on amounts and types of equipment, the allowances are significant enough for many small and medium-sized companies to see substantial savings. These provisions of the Tax Code have existed for a long time, but the 2018 tax changes were noteworthy. These include being able to take the deduction for the purchase of used equipment (as long as the equipment is “new to you”) as well as an increase in the limitation amounts. For tax year 2020, the IRS has increased, by approximately 4%, the maximum deduction and the maximum amount of equipment that can be purchased. This increase represents roughly the cost of living allowance implemented in 2019 (2.8%) and 2020 (1.6%).
What are the Section 179 Limits?
- Maximum amount that can be deducted is $1,040,000
- Maximum amount of equipment that can be purchased (and take the full deduction) is $2,590,000
- Equipment must be placed into service no later than December 31, 2020
What is Bonus Depreciation?
Section 168(k) allows for bonus depreciation (100% expensing) on eligible equipment and property, thus allowing accelerated depreciation for a reduced tax burden, similar to Section 179. A company can take both Section 179 and Bonus Depreciation allowances, but Section 179 must be applied first, and any amount over the $1,040,000 limit to Section 179 may then be taken in bonus depreciation.
What is Considered Eligible Equipment?
Eligible equipment includes heavy equipment and machinery, office and computer equipment, off-the-shelf software, some vehicles for business use, and more (check with your legal or tax advisor to determine if your purchases qualify).
In short, if the equipment, qualifies as a depreciable asset under Section 168, and is acquired for use in the operation of the business, it should be allowed.
The Tax Cuts and Jobs Act (TCJA) expanded the definition of "qualified real property" to include improvements (Qualified Improvement Property - QIP) to nonresidential real estate such as roofs; HVAC systems; fire protection, alarm and security systems. The CARES Act of 2020 further modified the rules for the treatment of QIP, classifying it as 15-year property rather than 39-year property, and no longer subjecting it to the $2 million a year limit for Bonus Depreciation. These changes are retroactive back to 2018 and taxpayers may go back and claim Bonus Depreciation on QIP placed in service on 2018 or 2019 tax returns, and for 2020 tax returns.
What are the Concerns about Using Section 179 and Bonus Depreciation?
Before you take Section 179 and/or bonus depreciation deductions, consult with your tax or legal advisor. While it’s true that the deductions effectively reduce your tax burden for the year in which the equipment was purchased, you may also give up future years’ depreciation, thereby impacting subsequent years’ tax burdens as well.
Additionally, accelerated depreciation of an asset results in a lower book value for that asset, which will affect the debt-to-worth ratio of your balance sheet. While this may not have significant impact on your business, it could affect your ability to borrow money for future purchases. And if you decide to sell the asset, specifically at a price higher than the current book value, you could pay taxes on the gains from that sale.
Evaluating the short and long-term effects of your purchase decisions and tax strategies is important to running your business. Your tax advisor can help you evaluate the effects of these tax strategies, so you can make the most informed decisions.
Buying equipment before the end of the year?
Want to know how much you can save with Section 179? Estimate your savings with the "Section 179 Calculator":
To learn more about the history of Section 179, read this report from the Congressional Research Service.