What is Section 179 All About?
Section 170 is the part of the United States Tax Code that allows taxpayers, or more specifically business owners, to deduct their expenses for buying certain types of business equipment. Depreciation is defined as the drop in the value of business assets, like machinery, equipment, tools, automobiles, because of the wear and tear inflicted upon them from use and other reasons. Section 179 Deduction grants a substantial benefit to business owners over depreciation. It allows them to immediately deduct the expenses of their equipment in the same year the equipment is purchased that would otherwise have to be calculated and deducted over the period of years the equipment is used. It also makes it far easier and simpler for businesses to buy new business equipment and calculate its value accurately.
Suppose a business was to start up and buy non-current assets for the company. In that case, it will need to depreciate them because of the wear and tear from the usage, the asset’s perishability, and the model of the asset becoming obsolete because of better and improved models being introduced in the market. Wouldn’t it be easier to calculate the total amount that needs to be depreciated per year and pay it all in one go rather than having to recalculate the depreciating figure every year and then paying it off on an annual basis? Obviously, companies would prefer to get this hefty process and calculation off their hands because there are chances that they might end up making a mistake if they do it every year. After all, the method of depreciation and its calculation can get complex.
How Does Section 179 Work?
Section 179 of IRC allows businesses to immediately deduct business expenses that are related to depreciable assets such as machinery, equipment, vehicles, and software. This enables businesses to lower their current-year tax liability rather than capitalizing an asset and depreciating it over time in future tax years. For further understanding, let’s consider a practical example. You purchased multiple desktops for the company, which your employees will use to complete business-related operations. Using a depreciation method, you will need to deduct an amount of each computer’s cost over its useful years. And for every year of use, you will be required to calculate a new figure that will be used to reduce the value of the computers. Section 179 allows the immediate reduction of the entire depreciation expense in a single year rather than you being forced to keep an accurate track of the depreciation of assets that won’t even last that long.
Section 179 was introduced by the US government to encourage all the companies operating in the country to invest in themselves and buy whatever equipment and machinery their business operations need and improve the services and products they provide. Due to its popularity, companies have also referred to it as a loophole. Section 179 has received two names: SUV tax loophole and Hummer Deduction. Businesses have widely used the tax deduction when writing off the purchase of business vehicles that qualified for it.
While using Section 179 to write off their company assets is common for big companies, small businesses in particular benefit the most from it. Due to the nature of the Section, small startups are in a better position to fully realize the value of deducting their expenses in the same year they purchased vehicles, equipment, and machinery for the company.
Taxpayers That Can Qualify for Section 179
The Section 179 2021 deduction has proven wildly popular with small and mid-sized companies. Needless to say, there are certain conditions that business assets need to meet if they are to qualify for Section 179. If the requirements for the Section are not fulfilled, the machinery or equipment will not be applicable to benefit from it.
To successfully qualify for Section 179 deduction, you must use a vehicle for business purposes (instead of personal use) more than 50% of the time. To stop business owners from using this Section on some of their personal cars which are not being used for business purposes, the US government included a clause that disqualifies any vehicle that has been used personally more than it has been driven for business operations. For a vehicle to successfully qualify for Section 179, it needs to be used by the business majority of the time. Any motor vehicle with 50% or less business usage will not qualify for any Section 179 deduction. Typically, owners calculate business use based on mileage.
Another requirement to fulfill to qualify for Section 179 2021 is the deadline before which all assets need to be purchased. To use the deduction for 2021, the equipment must be purchased/financed and put into service by 11:59 pm, 12/31/2021. Meaning, any business machinery or equipment that was purchased after the mentioned date will not be applicable to benefit from the Section 179 for the year 2021.
For the year 2021, the maximum amount that you may elect is $1,050,000 on the qualifying property that has been purchased and placed into the service during the 2021 tax year. If your purchases exceed $2.62 million, the deduction amount will be reduced dollar for dollar equal to the amount over $2.62 million.
What is Bonus Depreciation?
Bonus depreciation allows qualifying businesses that spend more than the Section 179 limit to depreciate up to 100% on the remaining purchase amount. Bonus depreciation is beneficial to companies that spend more than the allowed $2.62 million in a tax year. After A small business takes section 179 deductions, bonus depreciation may be applied to accelerate depreciation further.
For a better understanding, Bonus depreciation is a way for businesses that have gone through an unprofitable year or years with no taxable income to benefit from the deduction by paying a specific percentage of the total amount and carrying over the remainder to the following year, and paying it off when the company is able to.
Section 179 and the concept of bonus depreciation can be used in the same month if the company needs to split the total cost between years. For example, a company unable to make the full depreciation payment can deduct and pay half of the cost upfront and divide the rest over next years as it pleases. Do keep in mind that the business must deduct the entire cost with bonus depreciation even though the amount hasn’t been fully paid yet. The company must also deduct all purchased business assets for that asset category of the year. There are no limits to bonus depreciation, as there are no maximum claims with Section 179. The company can deduct an amount that is larger than its income. In the case of any unused deduction, it will automatically be forwarded to the following year.
What is Purchased equipment?
Purchases of business equipment, office furniture, computers, software, technology, and many other business assets qualify for Section 179. In some cases, even property-type assets can be eligible, provided the property can meet the strict IRS requirements of Section 179 and qualify for it. Any business machinery and equipment that has been declared for Section 179 Deduction needs to be put into the service of business operations during the year the company has declared it on the tax forms.
An Example for Better Understanding
Deductions Slips Away After $2,500,000
Ever since 2021, a business can expense up to $1,050,000 of eligible property. Spending anything beyond $2,620,000 on qualifying property assets for the company will reduce your deductions to a dollar-to-dollar basis. Let’s suppose the business makes a property purchase of $2,720,000; by doing so, the company has exceeded the cap limit by $100,000. And so, the maximum Section 179 Deduction expense will be [$1,050,000 – $100,000] $950,000.
The Net Income is the Ceiling
Section 179 Deduction that the company can benefit from is also limited by the business’s net income for the year. Strictly meaning, the business cannot deduct more money than it has made in the current financial year. For example, if the business has achieved a net income of $50,000 before taking into account Section 179 and purchased an eligible property valued at $60,000, the business deduction will be limited to $50,000. In this scenario, the company missed out on $10,000 worth of Section 179 deductions since the business didn’t make enough net income that year. However, there’s still hope. The company can carry the $10,000 deductions forward to the following year, as long as the firm’s net income allows it.