Davis & Bellomo

As part of the recently passed tax bills, small businesses can take advantage of bonus depreciation in 2010 and 2011 and enhancements in Section 179 expensing in 2010, 2011 and 2012. These provisions are intended to encourage small business owners to purchase and place new equipment into service.

First, let's understand the rules for each provision. For assets placed in service in 2010 or 2011, there are two periods that taxpayers need to know.  For assets placed in service before September 9, 2010 the bonus depreciation is 50% of the cost of the asset and for those assets placed in service after September 8, 2010 and before January 1, 2012 the bonus depreciation is 100% for the cost of the asset. For the remainder of this article, the term "bonus depreciation" is used to refer to all assets placed in service in 2010 and 2011. Bonus depreciation generally allows a taxpayer to deduct 50%/100% of the purchase price of qualifying assets placed in service. Qualifying property is new property: The “original use” of the property must begin with the taxpayer and have a depreciable life not exceeding 20 years. Because of the depreciable life limitation, real estate is not qualifying property. The bonus depreciation deduction is available to taxpayers regardless of income from the business activity in which the property is placed in service. Taxpayers are required to deduct bonus depreciation, unless they affirmatively elect out of deducting the bonus depreciation on the tax return for the year in which the asset was placed in service.

Section 179 allows taxpayers to elect to expense the cost of qualifying property rather than treat it as a capital expenditure and depreciate the asset. Qualifying property generally consists of tangible assets purchased by a business in an active trade or business. Unlike the bonus depreciation deduction, the “original use” of the assets does not need to begin with the taxpayer taking the deduction. Accordingly, used property which is new to the taxpayer is eligible for Section 179 expensing. While Section 179 expensing has been available for years, the new legislation increased the total amount of Section 179 expense that can be claimed in 2010 or 2011 to $500,000 and increased the investment limitation to $2 million. In 2012, the dollar and investment limits will be $125,000 and $500,000, respectively. The investment limitation is the maximum amount a taxpayer can invest before the benefit is reduced dollar for dollar; therefore, the ability to take advantage of Section 179 expensing in 2010 and 2011 is eliminated if a taxpayer invests $2.5 million. Because of the increase in the amount that can be expensed and the investment limitation, the Section 179 expensing provision is effectively extended to larger businesses. Like bonus depreciation deduction, Section 179 expensing is not allowed for real estate purchases. Unlike the bonus depreciation deduction, Section 179 expense is only available to those taxpayers who have income from their business. The Section179 deduction is an elective provision; therefore a taxpayer must affirmatively elect to take the Section 179 deduction.

What factors should be considered before taking advantage of these provisions? First, is new equipment necessary? For smaller purchases that allow a small business to operate, such as a laptop computer, it is advisable to purchase the property before year-end. However, for larger purchases, for example a delivery truck or a new point of sale computer system, it is necessary to determine the return on investment (ROI) of placing the asset in service. Just because the tax code essentially provides a subsidy to purchase the equipment does not necessarily mean that it's a good investment for the business. Thus, the purchase must make sound financial sense. Second, can the business afford to purchase the new equipment? If the business does not have the cash or credit facility to purchase the equipment, it will likely need to borrow money. Given the current lending environment, obtaining a loan may be difficult. It should be noted the legislation also had provisions to increase Small Business Administration lending. Therefore, it is important to discuss financing options with your banker to find the most economical options for you. Lastly, once the non-tax factors are considered, it is appropriate to determine what tax savings can be achieved on the 2010 tax return of the business or its owners if the business activity is a flow-through entity, such as a sole proprietorship, S corporation or partnership. For example, if the business does not have income, Section179 expense will not be available because of the income limitation for Section179 expensing. However, the bonus deprecation would still be available on the purchase of qualifying property.

Because the of the complexities of determining the use of these two provisions, it is necessary to seek the counsel of a qualified tax professional in planning the purchases  before year-end and the preparation of the 2010 tax return.

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