Tax Depreciation


Tax Depreciation

The IRS provides for two main methods to depreciate business property: MACRS and Section 179.

You can use MACRS to calculate tax depreciation by multiplying an asset’s unadjusted basis (the cost times the percentage used for business) by the specified depreciation rate for the related time period.

If you are depreciating property you placed in service before 1987, use the Accelerated Cost Recovery System (ACRS) or the same method you used in the past for tax depreciation deductions.

MACRS and Section 179: Income Tax Depreciation Only

GAAP does not consider Section 179 or MACRS acceptable cost allocation methods for financial reporting purposes, and disallows them. For this reason, when using either method, separate depreciation records must be kept for financial reporting and income tax reporting.

Immediate Tax Depreciation: Section 179

Section 179 of the IRS tax code allows businesses to deduct the entire cost of a qualifying asset during the tax year. This creates a significant, immediate tax savings for the business during the first year of acquiring assets, since the depreciation deduction for Section 179 equipment is not necessary in subsequent years.

The Small Business Jobs Act (SBJA) of 2010 increases the IRC section 179 limitations on expensing of depreciable business assets and expands the definition of qualified property to include certain real property for the 2010 and 2011 tax years.

Under SBJA, qualifying businesses can now expense up to $500,000 of section 179 property for tax years beginning in 2010 and 2011. Without SBJA, the expensing limit for section 179 property would have been $250,000 for 2010 and $25,000 for 2011.

For example, if you purchased a computer in 2010, you can deduct the entire cost of the computer, including sales tax, set-up fees, and shipping costs. It does not matter whether you paid cash or financed the computer. Unlike depreciation, however, you must use the asset over 50% of the time for business, and continue to use the asset over 50% during the years the asset would have been depreciated.

If you purchased a computer for $5,000 and use if for business 70% of the time, you can take a Section 179 deduction for $3,500. The remaining $1,500 is not deductible. If you used the computer 40% of the time, then you cannot take a Section 179 deduction. You can, however, depreciate the computer over 5 years based on 40% of the value of the computer ($2,000 spread over 5 years).

Rules for Section 179 Tax Depreciation

1. The property must be long-term tangible property.

2. You must use the property more than 50% of the time for business, including the year purchased.

3. The total amount of all section 125 tax deductions placed in service in 2010 cannot exceed $500,000.

4. Section 179 deductions cannot exceed net taxable business income. However, if you have a small business as a sole proprietor and receive a salary from work, you can include your salary in the calculation of net taxable income, including your spouse’s salary if you file a joint return.

5. Total equipment purchases are limited to $2,000,000 in 2010, a substantial increase from $800,000 in 2009. This is because the Section 179 tax depreciation is targeted for small business taxes, not larger corporations. For example, if you purchase $2,200,000 in equipment, then you must reduce section 179 tax depreciation to $300,000 ($500,000 less the $200,000 exceeded by total equipment purchases).

Tax Depreciation and Section 179: Use it or Lose It

If you do not take the Section 179 tax deduction on form 4562 in the year the tax return is due for assets placed in service during the year (including up to October 15 for extensions to file) , then you will have forfeited the Section 179 tax deduction. You may use MACRS tax depreciation to depreciate the asset in future years.

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