IRS Section 179 Expense and Depreciation

Section 179 of the IRS tax code allows a business to immediately deduct the entire cost of capital purchases (think equipment) from the company’s tax return. Subject to conditions of course.

“The 179 expense deduction is the ultimate accelerated depreciation technique.”
Gary Bode, CPA
Wilmington NC Accountant

Depreciation started as a way for an accountant to spread out the cost of equipment over the period of its expected usefulness. If a machine cost $50,000 and was expected to help production for five years, the accountant expensed $10,000 per year. Many variations of depreciation developed to account for cases where the usefulness of the machine was not uniform across the five years. Most accelerate depreciation such that greater expense is taken in the early years. However, for IRS purposes, the depreciation variations have more to do with taxation than the true life of the machine. Section 179 is an extreme example; where up to the entire cost can be deducted in the first tax year, regardless of the expected life of the machine. Its’ original purpose was to stimulate small business capital purchases by tax incentives. One consequence was the proliferation of SUVs purchased as business vehicles.

Very Basic Example

Wilmington NC Widgets, our demo company, buys a $50,000 piece of equipment in 2010. The CPA for Wilmington NC Widgets has two basic choices on how to handle this for the 2010 WNW tax return: The first technique is depreciation. In this example, the CPA can deduct $10,000 in 2010, and an additional $10,000 on the tax returns for the following four years. The second choice uses Section 179 where the CPA deducts the entire $50,000 on Wilmington NC Widgets’ 2010 tax return.

2010 Specifics

The IRS specifics change annually. In 2010, the Section 179 deduction allows the CPA for Wilmington NC Widgets to fully expense the first $134,000 in capital equipment expenditures. If WNW buys over $400,000 of capital equipment in 2010, it must subtract each dollar spent over $400,000 from the $134,000. Once the total capital purchases exceed $534,000, in 2010, there is no Section 179 deduction allowed and the CPA has to use some type of depreciation. For those dollars spent that exceed $134,000, standard MACRS depreciation rates apply.

Considerations for Electing Section 179

There are two potential problems with the Section 179 deduction. So the CPA has to look at the best interests of Wilmington NC Widgets. Section 179 only helps companies who are making a profit. There are many companies still trying to dig out from the recession and might not turn a profit in 2010. There is no sense in accelerated tax deductions if WNW doesn’t actually save on taxes by doing so. If a WNW fully expenses their capital equipment expenditures in 2010, then they have no depreciation for tax deductions in 2011 and beyond. Generally speaking, saving taxes now is better than saving taxes later. But this takes cash flow discipline. WNW is happy in 2010 if Section 179 markedly decreases taxes. Not so happy in 2011 and beyond perhaps.

Additional cash flow complications can arise with taking a Section 179 deduction if the $50,000 of equipment was financed. Imagine only $5,000 of the entire $50,000 purchase was paid in 2010. But the CPA can still deduct the entire $50,000 off Wilmington NC Widgets’ 2010 tax return. So in 2011, not only is WNW paying off the remaining $45,000 debt, it doesn’t get any tax deduction for it. A double whammy to cash flow.

If you need a free initial consult, please call Gary Bode, MSA, CPA, PC at (910) 399-2705.