Assets and equipment: what has your company purchased in the past year?
Major asset purchases can transform your company operations, but they have another benefit, too: they can lower your taxes.
Recording the depreciation expense of an asset using Section 179 or bonus depreciation can make a huge difference in the taxes you pay.
Curious to learn why? Below we’ll cover in detail how depreciation works and the 179 section and bonus depreciation method for accelerated depreciation.
What Is Depreciation?
For your business accounting, depreciation refers to the value of your asset or equipment each year that it is used. Companies that depreciate the value of equipment or an asset will report lower profits for that year and higher expenses due to the asset.
This will lower the taxes they have to pay. For this reason, paying higher amounts in depreciation can be beneficial to companies.
What is Section 179?
IRS (Internal Revenue Section) Section 179 allows businesses to deduct the full purchase price of certain equipment for the year it was put into service.
By deducting the entirety of the purchase price, it creates an initial expense deduction that is higher than the standard depreciation method. Therefore, the company faces a lower tax liability.
Companies can finance equipment or pay for equipment in cash. But to take advantage of the accelerated deprecation, there is one caveat. The tax code requires that the equipment be put into service before December 31 of the tax year.
If companies want to use 179, they need to plan ahead for receiving equipment so they can place it into service before the deadline.
179 allowances are very helpful for small and medium-sized companies. Many will get significant savings from using this method.
However, there are deduction limits for companies. In 2022, the spending cap on equipment purchases is $2,700,000 to be eligible for Section 179. Companies have a deduction limit of $1,080,000.
What Is Bonus Deprecation?
Bonus depreciation is another way that companies can minimize expenses. Section 168(k) includes provisions on bonus depreciation.
It allows for bonus depreciation (meaning 100% expensing) on certain equipment and property. Doing this creates accelerated depreciation and a lower tax burden, a similar result to using Section 179.
Companies can take both Section 179 and Bonus Depreciation allowances. However, companies must first take Section 179. Anything over the $1,080,000 limit can then be taken in bonus depreciation.
Note that companies must be profitable to take the Section 179 deduction. But with bonus depreciation, there is no business income limitation. You could take a net loss if you decide to take advantage of bonus depreciation.
What Is Eligible Equipment?
We described that both Section 179 and bonus depreciation applies to eligible equipment. What is this equipment exactly?
Eligible equipment includes heavy equipment and machinery. It also includes computer equipment, off-the-shelf software, and some vehicles for business use. It’s a good idea to check with a tax advisor to double-check what is eligible.
In the face of Covid-19, some modifications to business property and the use of sanitizing equipment could be eligible for the Section 179 deduction.
For Section 168k, equipment that qualifies as a depreciable asset is eligible for bonus depreciation.
Note the Tax Cuts and Jobs Act (TCJA), high expanded the definition of “qualified real property”. It now includes improvements to nonresidential real estate like fire alarms and new roofs. This could then be applied to your business expenses.
Five Differences to Know
Now that you know the basics of Section 179 and bonus depreciation, you may be more curious about which one to use. Below we’ll touch on five key differences to know that will help you make this decision.
And remember, you can use both in the same year!
1. Deduction Limits
Section 179 has annual limits on deceptions. For this year, that limit is $1,080,000. If your business spends more than the allowed $2,700,000 on business equipment, the amount you can deduct will start to decrease.
However, This depreciation isn’t limited to cost. This is a major difference between depreciation and IRS Section 179. You can deduct your entire investment using bonus depreciation, no matter how much you’re spending each year.
With Section 179, you can choose which assets you’ll deduct using this section. You can also decide which items to save for future tax breaks.
You can even split the deduction if you want. For instance, so you buy a new car for the business. You can claim half the cost of the car at purchase and then spread the rest of the purchase over a longer period of time.
Unlike the Section 179 deduction, bonus depreciation must cover. 100% of the asset’s cost. All assets must be in the same category. So, if you use depreciation for a five-year asset, you’ll have to apply it for all 5-year assets that you bought that year.
3. Business Income
Section 179 cannot be larger than your annual business income. Therefore you must be running a profit if you choose to use this method.
Meanwhile, you can use bonus depreciation and run a loss at the same time.
So, if you choose to use both Section 179 and bonus deprecation in the same year, you must be strategic. Section 179 gets applied first, so you’ll need to have a profit when you apply it.
4. Asset Coverage
Section 179 covers a host of assets. It includes real estate upgrades like adding a new roof. Bonus depreciation does not cover this category and only applies to new equipment.
5. Statutory End Date
The statutory end date is the date that the law is no longer in effect. The statutory end date for the 100 percent deduction for Bonus Depreciation is December 31st, 2022.
Then, it will decrease over the next few years: 80 percent in 2023, 60 percent in 2024, 40 percent in 2025, and 20 percent in 2026 if the law does not change. The law could be updated before 2023 to extend the policy.
Section 179 has no statutory end date, meaning that you can apply it indefinitely to your purchases.
Leveraging Your Depreciation Expense
Your depreciation expense can be a benefit for your company if you report it strategically. By using Section 179, bonus depreciation, or both, you can reduce your company’s tax burden.
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