Article: Managing Tax Depreciation


	Jim Schmidt

December 2006

Managing tax depreciation

Budgeting your company’s equipment purchases for the year can help you take advantage of a valuable tax deduction

For many small business owners, a valuable tax provision in recent tax years is the Section 179 first-year bonus depreciation deduction. The write-off can be significant: Up to $108,000 of first-year equipment purchases can be claimed as an immediate deduction. But the eligibility rules are confusing, and understanding the rules and budgeting your equipment replacements to fit within the Section 179 parameters are important parts of good tax planning.

Eligibility for the Section 179 first-year deduction is limited to smaller businesses that do not exceed an annual asset addition limit. For tax years beginning in 2006, that threshold is $430,000 of eligible purchases. Typically, assets eligible for Section 179 include equipment, fixtures, and vehicles, but not buildings. If the annual eligible purchases exceed $430,000, there is a dollar-for-dollar reduction in the eligible first-year deduction.

Example. Jones Construction files on a calendar year and purchased equipment of $450,000 during 2006. Jones must reduce its $108,000 Section 179 limit by $20,000, the amount by which its qualifying purchases exceed $430,000. Accordingly, Jones may claim a 2006 first-year Section 179 deduction of only $88,000 ($108,000 minus $20,000). Had Jones been able to better budget its equipment purchases for the year to remain below the $430,000 limit, its first-year deduction could have been $20,000 greater.

Other eligibility rules. In view of the significance of this deduction, it is important to understand the other eligibility restrictions:

Both new and used assets qualify, but if the asset is acquired through a trade, only the cash “boot” paid counts.

An entity’s Section 179 deduction is limited to its business net income. Accordingly, if an S corporation is in a loss position, no Section 179 deduction is allowed.

Property is ineligible if purchased from a related party.
Property that is purchased and leased to others faces a complicated calculation to determine eligibility (but this rule does not apply to C corporations).

Special vehicle rules. Normally, automobiles are subject to a small annual depreciation limit that makes the Section 179 deduction impractical. For example, for an automobile placed in service in 2006, the first-year depreciation limit is $2,960, assuming 100% business use.

But a special privilege exists for vehicles with a gross vehicle weight rating over 6,000 pounds, such as full-size SUVs, pickups and vans. Those vehicles are allowed up to $25,000 of first-year depreciation.

But even this $25,000 limit on larger trucks and vans has exceptions. Three categories of vehicles over 6,000 pounds continue to qualify for a full write-off of their tax cost under Section 179, up to the $108,000 limit:

vehicles with a seating capacity of more than nine persons behind the driver’s seat;
a pickup truck with at least a six-foot interior length cargo box; and
a van designed to carry cargo with no seating behind the driver’s seat.

Example. Intergalactic Manufacturing pays $38,000 for a full-size pickup truck with an eight-foot box to be used in the business. Assuming that this vehicle has a weight rating of over 6,000 pounds, the entire cost of the pickup may be deducted under Section 179 because the truck has an interior box of six feet or more. On the other hand, if the company purchased a four-door pickup with a short 5.5-foot interior length box or an enclosed SUV without an open box, the Section 179 deduction would be limited to $25,000.

Based in Mesa, Arizona, and serving closely held businesses in the East Valley, the Phoenix area and throughout Arizona, Schmidt Westergard & Company, PLLC, is an independent full-service tax, audit, accounting and business advisory firm focusing on the middle market.