You generally must depreciate the cost of property over its recovery period, a period assigned by the IRS. For example, equipment is generally depreciated over five years or seven years, automobiles are depreciated over five years, and rental real estate is depreciated over 27 1/2 years.
But there are two provisions that allow you to deduct more depreciation than you can under the usual rules: the Section 179 Deduction and the Special Depreciation Allowance. The Jobs and Growth Tax Relief Reconciliation Act of 2003 introduces important new, but temporary, changes to these provisions.
1. Section 179 Deduction: Now, code section 179 allows taxpayers to expense (that is, write off in one year) up to $102,000 of the cost of eligible business property in 2005. You can use this deduction even if you purchase the property on the last day of the year.
The deduction can be used only for property you purchase. For example, you cannot use the deduction for property you acquired in a trade, except to the extent you paid cash. Also, this deduction can be used only if you use the property more than 50 percent for business.
The deduction is reduced if you purchase more than $410,000 of eligible property for the year, up from $200,000 in previous years. Real property is not eligible for this deduction; however, under the new law, off-the-shelf software purchased for your business may be deducted as well. The deduction cannot exceed your business taxable income figured without regard to this deduction. Business taxable income includes self-employment income and wages and salaries. If you are married and file a joint return, you can take into account your spouse's business income.
If you sell the property before the end of its recovery period, you have to include in income the excess of the section 179 deduction you claimed over the depreciation you would have claimed for the time you owned it.
Whether to use the section 179 deduction instead of depreciation depends on several factors:
- Your current tax bracket compared to your future tax bracket.
- Your need for current tax savings.
- How long you expect to keep the property for which you claim the deduction.
2. Special Depreciation Allowance: In addition to the section 179 deduction, you may claim a special depreciation allowance of 50 percent of the basis of the eligible property. If you also claim the section 179 deduction for the property, the special allowance is figured using the basis reduced by the section 179 deduction.
Eligible property includes most depreciable property with a recovery period of 20 years or less and computer software that is depreciated over three years. This property must be purchased between May 6, 2003 and December 31, 2004 and placed in service (i.e. used in the business) before 2005. You must be the first person to use the property. Business use of the property must be more than 50 percent.
The limit on the depreciation for vehicles bought in 2004 with a gross weight of less than 6,000 pounds is $10,610 ($7,650 bonus depreciation plus the $2,960 "regular" auto depreciation) multiplied by the business-use percentage.
Unlike the section 179 deduction, there is no business-taxable income limit. Therefore, you can claim this deduction even if your business shows a loss. There is also no dollar limit. The special allowance must be claimed for all property in a particular class (see the caution note below), whereas the section 179 deduction is claimed on a property-by-property basis.
Example: The Main Street Pizza Shoppe purchases and uses $190,000 of new equipment in August, 2004. The new equipment consists of a new pizza oven, tables and chairs, and lighting fixtures (all seven-year property).
| Sec. 179 |
$102,000 |
|
| Bonus depreciation |
$44,000 |
$88,000 balance x 50% |
| Regular depreciation |
$6,288 |
$44,000 balance x 14.29% |
| Total write-off |
$152,288 |
|
Be aware: The Section 179 deduction is an election. You may expense any amount up to $102,000 of new equipment purchases, or not take the deduction at all.
The 50 percent bonus depreciation is a default. You may choose instead to use the 30 percent bonus depreciation or simply "opt out" of bonus depreciation all together. If you make one of the alternate choices, you are making that choice for all purchases within a particular property class. For example, if you have two eligible machines that are 5-year property, you may not claim the special allowance for only one of them.
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