Depreciation Provisions in the Small Business Jobs Act of 2010

Two valuable depreciation-related tax breaks were extended by the Small Business Jobs Act of 2010 (the Act, P.L. 111-240): higher Section 179 expensing limits for 2010 and 2011 and the extension of bonus depreciation through 2010. These tax breaks can make purchasing needed equipment more affordable.

Depreciation 101

Ordinarily when you buy equipment and other assets for your business, you’re required to depreciate the costs over several years for tax purposes. Sec. 179 allows you to “expense” — in other words, deduct immediately — as much as 100% of the cost of a qualified asset in the year you place it in service.

To qualify for depreciation or expensing, an asset must be “placed in service.” That means the asset is ready and available for use in your business — in other words, it’s operational and at the work site. But you don’t necessarily have to be using the asset. Backup equipment and replacement parts, for example, are placed in service when they’re available for use.

The Sec. 179 election is available for most equipment, “off-the-shelf” computer software, machinery, furniture and other tangible personal property purchased for use in an active trade or business.

The amount you can expense under Sec. 179 is subject to an annual limit, which is phased out on a dollar-for-dollar basis when your total investment in Sec. 179 property exceeds the phaseout threshold. Under the Small Business Jobs Act, for 2010 and 2011 the expensing limit has been increased to $500,000 and the phaseout threshold to $2,000,000. The $500,000 limit is reduced by $1 for every dollar of 2010 qualified purchases exceeding $2 million.

Virtually all small businesses and many medium sized businesses that don't have heavy machinery and equipment needs will be able to use expensing under the Act. For property placed in service in tax years beginning in 2010 or 2011, the Code Sec. 179 deduction won't phase out completely until the cost of expensing-eligible property exceeds $2,500,000 ($2,000,000 (beginning-of-phaseout amount) + $500,000 (dollar limitation)).

Special “New” Section 179 for Qualified Real Property

New for any tax year beginning in 2010 or 2011, a taxpayer may now elect to treat up to $250,000 of qualified real property as Code Sec. 179 property. Qualified real property includes certain qualified leasehold improvement property, qualified restaurant property and Qualified retail improvement property. Not all improvements qualify so contact us for assistance.

For purposes of applying the $500,000 expensing limitation under the Act, not more than $250,000 of the aggregate cost which is taken into account for any tax year can be attributable to qualified real property.

EXAMPLE: In 2010, X, a calendar-year taxpayer, places in service $400,000 of qualified restaurant property. For 2010, X can expense no more than $250,000 of the cost of the restaurant property.

Meeting the income limit

Sec. 179 limits expensing to a taxpayer’s taxable income from all sources, so you can’t use the election to generate a loss. If the taxable income limit prevents you from deducting all of your Sec. 179 expenses this year, you can carry over the unused deductions to future years. However, you may be better off forgoing some or all of the election this year and using ordinary depreciation deductions to generate a loss.

If you’re a sole proprietor for federal tax purposes, taxable income includes any wages you earn as an employee plus your spouse’s wages or self-employment income if you file a joint return. And you can carry over and deduct in future tax years expenses you’re unable to deduct because of the income limit.

Let’s say, for example, John invests $100,000 in equipment for a startup business. The company has no taxable income for the year, but John’s wife, Mary, has $110,000 in taxable income from her job. John and Mary can deduct the entire $100,000 investment on their tax return. (The rules are more complicated for pass-through entities, such as partnerships and S corporations.)

Timing purchases

The higher Sec. 179 expensing limits apply for calendar year 2010 and 2011 or a business’s fiscal year that begins in 2010 and 2011.

A tax rule of thumb advises that you should take as many deductions as possible this year and defer as much income as possible to later years. So if you can afford it, accelerating purchases into one year can make sense.

But like all rules, there are exceptions. For example, if you anticipate being in a higher income tax bracket in future years, you may be better off holding off on asset purchases — even if it means you’ll be subject to lower Sec. 179 expensing limits. Why? Because deductions save more tax dollars when you’re paying tax at a higher rate. For example, a $10,000 deduction saves $2,800 in taxes if you’re being taxed at the 28% rate, but it saves $3,500 if you’re being taxed at the 35% rate.

Bonus First-Year Depreciation Extended Through 2010

The Act extends 50% bonus first-year depreciation for one year, i.e., makes it available for qualifying property acquired and placed in service in 2010. Bonus depreciation allowed you to accelerate your depreciation deduction for a qualified asset by taking more of it for the year of purchase, in this case 50% of an eligible asset’s adjusted basis. A key factor for bonus property is that the property must be new or its original use generally must begin with the taxpayer.

Bonus depreciation isn’t subject to any asset purchase limits, so businesses ineligible for Sec. 179 expensing can take advantage of it. And businesses that qualify for Sec. 179 expensing may take bonus depreciation on asset purchases in excess of the $250,000 Sec. 179 limit. (Of course, they had to keep in mind the $800,000 Sec. 179 phaseout threshold.)

EXAMPLE: In February of 2010, ABC Inc., a calendar-year business, bought and placed in service $1 million of new 5-year MACRS property. For 2010 under the new Act, ABC can expense $500,000 of the cost of the 5-year MACRS property (there's no phaseout of expensing because ABC's acquisitions don't exceed $2 million). ABC can claim a first-year depreciation deduction of $250,000 ($1,000,000 - $500,000 expensing × .50 bonus depreciation allowance). It also may claim a regular first-year depreciation deduction allowance of $50,000 ($1,000,000 - $500,000 expensing - $250,000 bonus depreciation × .20 first year allowance). Total first year writeoff for the February assets under the Act: $800,000 ($500,000 expensing + $250,000 bonus depreciation + $50,000 regular first year depreciation).

Getting the best result

To get the best tax result from your asset purchases and depreciation-related deductions, examine your overall tax situation with your tax advisor — before year end, so you still have time to make asset purchases and benefit from the 2010 tax breaks if appropriate.

Sidebar: How to avoid recapture

Be sure that property you expense under Section 179 is used more than 50% of the time for business. If business use drops below 50%, you’ll have to recapture a portion of the Section 179 deduction and pay taxes and interest on that amount. Penalties may apply.

The recaptured amount is the excess amount you expensed minus the amount you would have deducted under regular depreciation rules.

State Depreciation

Be aware that many states (including Wisconsin) have not adopted the new federal depreciation limits therefore state tax depreciation differences will need to be tracked for certain business assets.