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Update on the Section 179 Deduction Tax Break

The latest tax law includes important depreciation changes that will benefit businesses for the 2013 tax year (and 2012 if you haven't filed yet). Under Section 179, a business can deduct qualifying assets (including most software) in the year they are placed in service, rather than writing them off over several years under the regular depreciation rules. This article explains the rules.

The Section 179 deduction is valuable because it allows businesses to deduct as depreciation up to 100% of the cost of qualifying asset additions in Year 1 instead of depreciating the cost over a number of years. The American Taxpayer Relief Act of 2012 (better known as the "fiscal cliff" legislation) included several taxpayer-friendly changes to the Section 179 rules.

More Generous Deduction Limits

For qualifying property placed in service in tax years beginning in 2012 and 2013, the fiscal cliff legislation restored the maximum Section 179 deduction to $500,000 (same as for tax years beginning in 2010 and 2011). Without this change, the maximum deduction for tax years beginning in 2012 was scheduled to drop to only $139,000 ($125,000 adjusted for inflation), and the maximum deduction for tax years beginning in 2013 would have been only $25,000.

Example 1: A calendar-year corporation adds $500,000 worth of new and used equipment and software during its 2013 tax year. Thanks to the more-generous Section 179 deduction limit, the corporation can probably deduct the entire $500,000 on its 2013 federal income tax return. Without the fiscal cliff legislation, the corporation's maximum Section 179 deduction would have been only $25,000.

The fiscal cliff legislation also restored the higher threshold for the dollar-for-dollar Section 179 deduction phase-out rule to $2 million for tax years beginning in 2012 and 2013. Without this change, the phase-out threshold for tax years beginning in 2012 would have been only $560,000 ($500,000 adjusted for inflation), and the threshold for tax years beginning in 2013 would have been only $200,000.

Example 2: A calendar-year corporation adds $2,100,000 worth of new and used equipment and software during its 2013 tax year. Under the Section 179 deduction privilege, the corporation can immediately deduct up to $400,000 on its 2013 federal income tax return ($500,000 maximum Section 179 deduction reduced dollar-for-dollar by the $100,000 excess over the $2 million phase-out threshold). Without the fiscal cliff legislation, the corporation would have been completely ineligible for any Section 179 deduction due to the phase-out rule.

Key Point: Thanks to the generous $2 million phase-out threshold, many more medium-sized businesses will be able to claim tax-saving Section 179 deductions in tax years beginning in 2012 and 2013.

Other Favorable Rules Extended

The fiscal cliff legislation also extended several temporary liberalizations in the Section 179 rules through tax years beginning in 2013. For example, most purchased software costs placed in service in tax years beginning in 2012 and 2013 will continue to be eligible for the Section 179 deduction, and Section 179 deduction elections made for tax years beginning in 2012 and 2013 can be revoked. Unless Congress takes action, however, these liberalizations will not be available for tax years beginning in 2014.

Section 179 Deductions for Qualified Real Property Costs

Before 2010, real property costs were generally ineligible for the Section 179 deduction privilege. However for tax years beginning in 2010 and 2011, a temporary exception allowed businesses to claim Section 179 deductions for up to $250,000 of qualified real property costs. The fiscal cliff legislation extended this favorable provision to cover tax years beginning in 2012 and 2013. Eligible property includes qualified leasehold improvements, qualified restaurant buildings and improvements, and qualified retail improvements. Consult your adviser for details on exactly what types of property fit into these tax-favored categories.

Qualified real property costs that are immediately written off under the temporary Section 179 deduction privilege reduce the taxpayer's overall $500,000 Section 179 deduction allowance dollar-for-dollar.

Section 179 deductions for qualified real property costs are subject to all the other standard Section 179 rules such as the deduction phase-out rule, the taxable business income limitation, and the special rules that apply to Section 179 deductions claimed by pass-through entities. Consult your EHTC adviser for details on these rules.

Example 3:  In 2013, a calendar-year corporation places in service $150,000 of eligible personal property assets and $250,000 of qualified real property assets. The corporation's maximum Section 179 deduction for the year is $400,000 ($150,000 for personal property plus $250,000 for real property).
Example 4: This year, a calendar-year corporation places in service $350,000 of eligible personal property assets and $550,000 of qualified real property assets. The corporation's maximum Section 179 deduction for 2013 is $500,000. The $500,000 can be comprised of any combination of eligible personal property costs and qualified real property costs, as long as the separate $250,000 limitation on qualified real property costs is not exceeded. For example, the corporation could expense $250,000 of real property and $250,000 of personal property. Or it could expense the entire $350,000 of personal property costs and $150,000 of real property costs.

Conclusion

The current favorable Section 179 rules can be a big tax-saver for eligible small and medium-sized businesses. However, there are a number of tax-law restrictions that are not covered in this article. For example, the Section 179 deduction cannot exceed the taxpayer's business taxable income calculated before the Section 179 deduction. As another example, special limitations apply to partnership and S corporation businesses and their owners.

Consult your EHTC adviser for details and strategies on how to take advantage of today's taxpayer-friendly Section 179 rules, which are scheduled to be unavailable in tax years beginning after 2013 -- unless Congress acts to extend them.

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