By John Marquardt and Matthew Becker
Dec. 1, 2011
Purchasing new assets is a great way for businesses to upgrade technology, expand capabilities and generate new business. Often, the significant cost involved means organizations wait to make needed additions. Two current provisions in the tax code make purchasing new assets before year-end very attractive. These so-called “accelerated tax deductions” allow taxpayers to deduct some, or all, of the capital goods price in the year of purchase. These rules can generate a significant current-year tax deduction instead of the usual requirement to capitalize and deduct the cost of purchases over time via depreciation expense. In essence, the accelerated tax deductions can lower the ultimate cost of an investment.
The sections of the tax code that provide these benefits are due to change or expire on January 1, 2012, making the remainder of 2011 an ideal time to purchase new assets or sell equipment using the expiring benefits as an incentive to customers.
Two areas of tax law that provide for purchase price expensing beyond standard tax depreciation are commonly known as “bonus depreciation” and “section 179.”
Bonus depreciation is the most frequently utilized and most powerful benefit, as qualifying property is eligible for a 100 percent tax deduction of the purchase price in the year it is placed in service. In order to qualify, assets must meet a variety of requirements concerning property type, use, and the dates purchased and placed in service.
Property types that qualify for bonus depreciation include furniture, fixtures, equipment, computer and information systems, software, and a variety of others commonly manufactured or purchased by small businesses. These must be purchased new by the taxpayer to be eligible for bonus depreciation, and only the business use portion qualifies. The purchase and in-service dates of the property are also critical to qualify for bonus depreciation: For the 100 percent deduction, property must be purchased after Sept. 8, 2010, and before Jan. 1, 2012, and placed in service prior to Jan. 1, 2012. Bonus depreciation will be limited to a 50 percent deduction in 2012, so a purchase in November or December of 2011 offers a much greater incentive to offset taxable income.
Section 179 expense is an alternative option that allows a deduction of the full purchase price of qualifying property up to a limit of $500,000. However, that amount is reduced to the extent that the total cost of section 179 property exceeds $2,000,000 for the tax year. Again, timing is critical as both limits are set to fall considerably next year. Beginning in 2012, the total deduction allowed will be limited to $125,000 and phased out as the total cost of section 179 property exceeds $500,000.
Differences between Bonus Depreciation and Section 179
Bonus depreciation and section 179 both offer accelerated tax deductions, but have significant differences. Bonus depreciation allows unlimited deductions for qualifying property with no phase-out threshold, whereas section 179 limits both deductions and total purchase cost. Section 179 deductions may apply to acquisitions of used property, while bonus depreciation requires assets to be new. Additionally, section 179 deductions are limited to a taxpayer’s income but bonus depreciation can be used to create a net operating loss, which can be carried back to offset past taxes or carried forward to offset future income.
Regardless of which option is most advantageous, business owners should act soon if they wish to reap the benefits. These provisions were designed to encourage investment and, given the limited time remaining for the highest deduction amounts, should provide significant incentive to make purchases. Organizations may need new equipment or technology to increase efficiency, expand capacity, or explore new business opportunities, and the ability to offset income with purchase expenses can minimize both risk and taxes. Even if a business is not expecting significant income, bonus depreciation deductions can create a loss carryover to deduct in future, more profitable periods. Also, emphasizing bonus depreciation and section 179 expense opportunities to customers can encourage year-end sales and inventory reductions for manufacturers. Many Michigan businesses are using the favored tax treatment of new asset purchases to encourage customers to buy their product before the end of 2011.
John Marquardt and Matthew Becker are Tax Partners at BDO USA LLP in Detroit and Grand Rapids respectively. BDO USA LLP is a U.S. professional services firm providing assurance, tax, financial advisory and consulting services to a wide range of publicly traded and privately held companies. More information at www.bdo.com.