The Section 179 depreciation deduction for small businesses is a section in the internal revenue code that basically allows small business owners to accelerate their depreciation of fixed assets. This is specifically for small businesses because there are limitations on how much you can deduct and how much you can spend on fixed assets before the deduction starts phasing out. For example, for 2020 the maximum deduction per year at is $100,040,000. That amount starts to phase out once you purchase more than $200,540,000 worth of equipment or fixed assets, and it completely phases out once you purchase more than $300,630,000 of fixed assets.
A fixed asset is a large or expensive asset that is supposed to last you for several years. Things like a desk, equipment, machinery, or a vehicle. Normally when you buy these fixed assets you are required to depreciate them over their useful life. These fixed assets are generally depreciated over a 7-year period.
Section 179 allows small businesses to depreciate the full cost of the fixed asset in the first year that it was purchased and placed into service. This can have a significant effect on your small business tax return. For example, let’s say you purchase a $7,000 desk for your small business. Using the straight-line depreciation method, you would take a $1,000 deduction every year for 7 years. After the seven years you can no longer take a deduction for the desk. Applying Section 179 to that $7,000 desk you now get to take a $7,000 deduction in the year you purchased it and put it to put it into service.
First you must purchase qualified property, which is basically any tangible asset that you can buy that is not real estate, land, or most residential improvements. It can be machinery, equipment, computers, farm equipment, vehicles, furniture, those kinds of things.Second, when you purchase the fixed asset, you have to place it into service in the year that you bought it, which means you begin to use it in the year that it was purchased. For example, you cannot purchase a bunch of laptops because you found a good deal and then store them away for future use. Those laptops would not be eligible for the Section 179 depreciation because they are not being “put into service” in the year they were purchased. You must purchase the asset and then place it into service in the same year for the asset to qualify.
Remember those limitations mentioned earlier related to the Section 179 depreciation? When you max out on your Section 179 depreciation amount, thanks to the Trump tax law, there is something called Bonus Depreciation that allows you to take 100% depreciation on any assets that you purchase and use in the same year. Same exceptions apply here - real estate, land, and most residential improvements are not eligible. Basically, you take the Section 179 deduction first and if you still have assets that are not fully depreciated, then you have the option to take a Bonus Depreciation to fully depreciate them. There are no real limitations to the Bonus Depreciation.
There are some differences on how the Section 179 deduction and Bonus Depreciation deduction can affect your overall business profit or loss. A Bonus Depreciation deduction will allow you to bring your business to a net loss while the Section 179 deduction does not allow you bring your business to a loss. The Section 179 deduction will stop at zero and the remaining deduction will carry over to the following year.
There are some special rules around depreciating cars under Section 179 of the internal revenue code. Any vehicle that is a commercial vehicle will qualify for the Section 179 deduction. A commercial vehicle is defined as a vehicle with two seats, a cargo barrier, and cargo space in the back (no seats in the back). A bus also qualifies as a commercial vehicle. A vehicle with more than 8 rows of seating would be considered a bus. Any legitimate commercial vehicle would qualify for the Section 179 deduction.What about passenger vehicles? For a passenger vehicle to qualify for any Section 179 deduction, the gross vehicle weight rating by the manufacturer must be greater than 6,000 pounds. If your vehicle meets the criteria, then you get a maximum $25,000 Section 179 deduction in your first year. If your vehicle is worth more than $25,000 you can take the remaining value of the car in Bonus Depreciation. Which is good news unless you plan on selling it in a couple years. If you plan on selling the car in the first couple of years, you are going to be hit with a large tax bill.Here is an example. Say you buy a 2021 BMW x5 for $75,000 in the current year (2020). The GVWR, the gross vehicle weight rating on that car is 6,559 pounds, which means it meets the criteria. In 2020 you can take the Section 179 deduction of $25,000 and you can take the Bonus Depreciation of $50,000. This means you have totally depreciated the car value of $75,000 in the year it was purchased. In that sense you have essentially written off the entire cost of the car. Because you fully depreciate the car in the year it was purchased, the book value of your car is now zero. Your market value is still the actual market value but from an accounting perspective, the book value of the car is zero. That means if you decide to sell your car in two years, three years, even five years you must recapture that depreciation as income, which will affect your taxes.Here's the difference, if you buy a car for $75,000 and you depreciate it down to zero and then sell the car in two years for $55,000 then you have $55,000 of income that must be reported because you fully depreciated the car in the first year. Now if you bought the car for $75,000 and you took normal depreciation over five years at $15,000 per year, after two years your book value would be $45,000. If you sold the car at the end of those 2 years for $55,000, then your gain, your reportable income would only be $10,000.
There are a couple of options available to small business owners concerning fixed asset depreciation: straight-line depreciation, or accelerated depreciation. As discussed, you can use both Section 179 and Bonus Depreciation depending on what is best for your business.We are here to help. If you need assistance determining which method is best for your business, reach out to us at www.nguyencpas.com or support@nguyencpas.com and schedule a consultation with one of our advisors.
