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Every business needs equipment. However, sometimes it can be difficult to justify the purchase of a large piece of equipment on a limited budget. The section 179 deduction of the IRS tax code offers an incentive to all businesses, particularly small- and medium-sized businesses, to invest in themselves and move forward with the purchase.
Normally when a company buys equipment, they are required to depreciate the expense of the item over time, usually over a “normal” aging cycle as defined by the IRS. In theory, this allows a company to match their expenses incurred with the actual operation of the equipment. For example, when you purchase a vehicle for business use, it’s assumed that you’ll receive about 5 years of use out of it. Naturally, you won’t get “5 years’ worth” in the first year, so you depreciate a portion of the cost of the vehicle over the next 5 tax years after the purchase.
Section 179 allows for a little bit different methodology to deducting your purchase. Instead of depreciating the vehicle over time, you are allowed to write off the entire cost in the tax year of purchase up to $25,000. Beyond the $25,000 threshold, a business can claim up to $200,000 in equipment purchases before the deduction amount is reduced. Any amount above the $25,000 limit is subject to standard depreciation. Additionally, there is no requirement as to the condition of the equipment: both new and used equipment qualify for the deduction. The main stipulation is that the equipment must be primarily for business use.
For example, if you purchase a tractor-trailer combo for your business at a cost of $100,000 and choose the straight-line method of depreciation over 5 years, your first year tax deduction would be $40,000. Here’s how:
- Section 179 allows an initial write-off of $25,000. This leaves $75,000 to be depreciated over the next 5 years.
- Straight-line depreciation requires an identical annual deduction, which is where the name “straight-line” comes from. In order to determine the annual deduction, divide the remaining balance of $75,000 by the number of years, in this case 5. The annual deduction will be $15,000.
- Your business’s first year tax deduction will be $25,000 + $15,000 = $40,000. As a side note, if your tax rate is 35%, your total tax liability is reduced by $14,000 in the first year. ($40,000 x 35% = $14,000)
- This leaves the remaining $60,000 to be deducted over the next 4 tax years at $15,000 per year.
The goal of this deduction is to encourage businesses to invest in themselves while simultaneously stimulating the economy. If you have a particularly profitable year, it may benefit your company even more to make the large equipment purchase that you’ve been postponing in order to reduce your tax liability.
The amount and specifics of the section 179 deduction are subject to change each tax year. The dollar amounts listed in this post are only applicable to 2014. Additionally, some equipment purchases are not eligible for the section 179 deduction.