Dear Tax Talk,
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I am taking an income tax class and am totally confused about Section 179 deduction and special depreciation allowance. Can you shed some light?
If you think depreciation is hard, wait until you have to deal with recapture.
Basically when a business buys a long-lived asset -- for example, computers -- it cannot take a deduction for the full cost in the year of acquisition. Instead the business has to capitalize the cost of the equipment as an asset and claim annual depreciation allowances over the asset's useful life as determined by law. The useful life of a computer for tax purposes is five years, meaning the cost of a computer purchased in 2011 would be recovered by deducting a portion of its original cost in 2011 to 2016.
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Section 179 deduction and the special depreciation allowance, or SDA (sometimes referred to as bonus depreciation), allow for a more rapid write-off of the cost of acquiring property, plant and equipment by a business. Section 179 and SDA apply in most part to personal property used in an operating business, to which I'll limit this discussion. Section 179 and SDA rules apply differently or not at all to autos, foreign-based assets and real property.
The most important difference is both new and used equipment qualify for Section 179 deduction (as long as the used equipment is new to the taxpayer), while bonus depreciation covers new equipment only. Bonus depreciation is useful to very large businesses spending more than $2 million on new capital equipment in 2011. Section 179 is only available to a business with $2 million or less in purchases of Section 179 property during the year. Businesses with a net loss in 2011 qualify for bonus depreciation on new equipment. Section 179 is limited to taxable income and cannot increase a loss, where the special depreciation allowance can.
Both allowances can create tax advantages for financed property acquisitions. For example, suppose a business buys a piece of $100,000 equipment that is 100% financed over seven years. Assume the business is in the 35% tax bracket. With a 100% write-off, the business can save $35,000 in taxes with a small layout for the loan payback.
From a tax policy standpoint, the expensing deductions encourage investment in property, which can generate jobs and growth.
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