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If you run a business, you may have heard the term “Section 179 deductions” thrown around from time to time during tax season. While most people view it as some sort of mysteriously complicated tax jargon, it is not as complex as it seems. With taxes being one of the most significant expenses for many business owners, taking a little bit of time to understand how to leverage this tax code to cut down on tax expenses every year is more than worth it. Let’s go ahead and break it down.
What is Section 179 Exactly?
Simply put, Section 179 is an ongoing tax deduction created by the U.S. government. It is designed for encouraging businesses to either purchase or finance equipment for business use by allowing them to deduct its costs from their taxable income. This means a lower taxable income and ultimately more money in your pocket.
Pretty cool right? The thought of claiming all your purchases as business expenses in order to pay fewer taxes seems like the ultimate tax code. Well, not so fast. While it definitely has its perks, the Section 179 tax code is reserved specifically for “depreciating assets,” meaning actual assets purchased and used for your business 50% or more of the time.
Here are a few popular examples:
- Office Furniture
- Computers
- Office Equipment
- Computer Software
- Tools (i.e. chainsaws, welding equipment, pulley systems etc.)
- Improvements specifically for your business’ building (i.e. HVAC, roofing, security systems, fire hydrants, water heaters, etc.)
- Business-related property attached to your building (i.e. large printing presses, manufacturing & machinery equipment, etc.)
- Business Vehicles with a 6,000+ lb gross weight
It is necessary to note that, whether they are new or used, the examples of qualifying equipment above still are valid. The catch is that they must be new to you, meaning that their purpose was mainly for business use at the time of purchasing, leasing, or financing them. The entire idea behind promoting tax breaks for these depreciating assets is to spread the cost of these assets over a certain number of usable years. As the assets depreciate over the years, so will the tax deduction benefits that you will be able to capitalize on.
How Does Section 179 Work?
In the eyes of the IRS, property qualified for tax code Section 179 must be “tangible, depreciable, personal property acquired for use in the active conduct of a trade or business.”
Section 179 deductions are designed to essentially speed up the deduction process on your business equipment assets, taking all the cost as a deduction in the first year. Not only do you get the full cost deduction benefits, but there are also additional first-year depreciation bonuses available to you as well. We will explain this more in-depth shortly, but for now, let us understand more about Section 179.
The single most common misconception regarding this deduction is that you can claim your personal vehicle as qualified property for a deduction – in most cases this is false. Section 179 deductions only apply to property used for business purposes for 50% or more of the time it is in use.
For example, if you purchased a van specifically for food deliveries for your restaurant, and use it 75% of the time for food deliveries or other restaurant-related activities, then you can safely apply a 75% Section 179 deduction of the full price that you purchased the van for. If you purchased qualified property, such as a van, for business purposes, but ended up using it for less than 50% of the time for actual business, no deductions can legally be applied.
So how do you do the math?
While your accountant or tax preparer will do the bulk of the calculations for you, here is what the process typically looks like.
First, you will need to purchase the qualified property and start using it for your business during the tax year that you would like to have it qualify under.
Keep your records of the purchase. They should comprise your date of purchase, the date that you began using it, your estimated amount of usage, and all the costs associated with the qualified property
You will provide all the documentation with your tax preparer or accountant, who will do the bulk of the calculations for you
Expect the deduction amount to equal the cost of the qualified property times the percentage that it was used for business. For example, a 20,000-dollar van used 50% of the time for business during its first year in use, will equal a 10,000-dollar deduction
Your tax professional will have you fill out the form to make the deduction, which currently is IRS Form 4562
If you only ended up deducting part of the cost of the property, you may be eligible to depreciate the cost that you did not deduct, meaning you will be able to spread out the remaining amount over the usable life of the asset.
What is the Difference Between Section 179 and Bonus Depreciation?
While both Section 179 and Bonus depreciation deductions provide tax benefits to business owners, using them both synchronically will provide you with the greatest deduction benefits. The thing most people enjoy about bonus depreciations is that they are generally easier to understand; however, it is important to note that the IRS typically requires most businesses to capitalize on Section 179 tax deductions first before combining them.
So what are bonus depreciations exactly? According to Investopedia, a bonus depreciation is “a tax incentive that allows a business to immediately deduct a large percentage of the purchase price of eligible assets, such as machinery, rather than write them off over the “useful life” of that asset.” In previous years, this tax break was capped at 50% of the total qualified asset cost, however, after the American Taxpayer Relief Act was implemented, the total cap was raised to 100%. This immediate high percentage deduction is what makes them so attractive to business owners.
How can Section 179 and Bonus Depreciations Work Together?
Now that we have an idea of how bonus depreciations work, let’s compare them with the coveted Section 179 tax code.
Section 179 Annual Limit
As of 2020, the Section 179 maximum deduction for an individual business asset is $1,040,000, with an overall cap per business at $2,590,000.
Section 179 Flexibility
One of the key benefits is the ability to choose specifically which purchases to claim for the current tax year and which ones to hold off on for future tax deduction benefits. In addition, you can actually split up the deduction amount for a qualified asset so that its benefits can be spread out evenly for its operational years. An example would be to claim half of a company van’s purchase price for this year, and the remaining half of its cost among the next 5 years.
Bonus Depreciation Annual Limit
The single biggest difference between the two is that there are currently no annual limits, meaning that the entire costs for qualifying properties can be deducted regardless of a company’s annual spend.
Bonus Depreciation Flexibility
The downfall for bonus depreciations is the lack of flexibility to only partially claim tax break benefits.
After understanding some of the pros and cons of both tax breaks, it is clear why you would want to consider using both deductions cohesively. While Section 179 offers more flexibility and customization, it has annual limits. Whereas bonus depreciations have no annual limits but offer limited flexibility. If you are a larger business, you will reap much more bonus depreciation advantages when spending over 2.59 million dollars on qualifying assets due to no annual limitations.
Despite their key differences, it can still be confusing on how to specifically maximize the benefits of both tax deduction benefits for your business. A good tax preparation professional will be able to walk you through your most optimal options.
Bringing Everything Together
By now you know more than most about Section 179 tax deductions as well as bonus depreciations, but in case you skipped to the bottom, let us summarize each tax benefit for you.
Section 179 allows business owners to deduct the full cost of qualified assets, such as business vehicles, furniture, and equipment, from their taxes as a business expense. Qualified property is generally limited to tangible, depreciable, business assets acquired specifically to be used for business purposes 50% or more of the time during its operational lifespan. To claim this deduction, you will need to fill out part 1 of IRS Form 4562.
Bonus depreciation accelerates depreciation of business assets by allowing a business to write off the full cost of the qualified asset within the same year that the company begins utilizing it. One of the biggest advantages of bonus depreciation is the fact that it does not have any annual limits to the amount you can claim.
With that said, every business has unique circumstances. Because tax laws are constantly changing, it is advised to speak with your tax professional to learn how your business can benefit from the Section 179 and bonus depreciation tax breaks available.