Section 179 expensing has been retroactively enhanced in The American Taxpayer Relief Act of 2012, the so-called fiscal cliff legislation that was enacted on Jan. 2, 2013.
Section 179 of the tax law historically was a $25,000 allowance for expensing certain new or used assets – generally furniture, fixtures, equipment and some software – in lieu of recovering cost through depreciation deductions over a number of years.
The expensing limit has been increased over the years and was at an all-time high of $500,000 for eligible purchases starting in 2010. It had dropped to $139,000 during 2012 and was scheduled to drop to $25,000 in 2013. But both limits were increased to $500,000 by the new law.
Congress believes that Section 179 expensing provides two important benefits for small businesses, including builders:
- By accelerating tax savings, expensing lowers the cost of capital for business assets. With a lower cost of capital, Congress believes small businesses will invest in more equipment and employ more workers. Small businesses are defined by the amount of fixed asset additions they make during the year, currently up to $2 million.
- Expensing eliminates depreciation record keeping requirements with respect to expensed property. However, many states do not fully conform to the federal tax rules, so separate state tax records may be required.
Property qualifying for the expensing option is depreciable tangible personal property – not real property such as buildings – and off-the-shelf computer software that is purchased for use in the active conduct of a trade or business. Business assets eligible for expensing include machinery, equipment, furniture and vehicles. There are caps on expensing SUVs or “luxury autos” used in a business.
Congress also made the decision that certain real property, namely leasehold improvements, restaurant property and retail improvement property, should be included in the Section 179 provision – up to $250,000 of the $500,000 expensing limit – to encourage small businesses to invest in those types of real property.
Leasehold improvements are any improvements to an interior portion of a building that is nonresidential real property. The improvements must be made by either the tenant or the landlord to a portion of the building occupied exclusively by the tenant. The improvements must be placed in service more than three years after the building itself was placed in service.
Restaurant property includes a building or an improvement to a building in which more than 50 percent of the building’s square footage is devoted to the preparation of, and seating for, consumption of prepared meals.
Retail improvement property is any improvement to an interior portion of a building that is nonresidential real property used in the retail trade or business of selling tangible personal property to the general public, for example, grocery stores, convenience stores, hardware stores and clothing stores.
Establishments primarily engaged in providing services, such as professional services, financial services, personal services, health services and entertainment, do not qualify. The improvement must be placed in service more than three years after the building itself was placed in service.
When the cost of qualifying property placed in service during the year exceeds $2 million, the Section 179 expensing is reduced dollar-for-dollar and is totally phased out at $2.5 million of investment. At that point, the cost is recovered through depreciation rather than expensing.
Expensing is allowed up to the amount of taxable income from the active conduct of any trade or business, not just the business in which the expensed property is used.
While expensing may be applied to new or used assets, a companion tax law provision applies only to new assets that have a tax depreciation life of 20 years or less, which excludes real property. Bonus depreciation of 100 percent of the cost of new assets that was available in 2011 was extended at a 50 percent level for 2012 and 2013.
While expensing produces a cash flow benefit upfront, it should be remembered that the costs have already been recovered through this expensing and, therefore, are not available to deduct in future years.
When the cost of business assets has been financed, loan principal payments must be funded in future years at the same time that taxes, which were reduced in the year assets were placed in service, return to a more normalized level. A taxpayer may amend or revoke an expensing election for prior years.
In addition to reviewing prior years, it may be prudent tax planning to consider 2013 expensing opportunities, since the $500,000 limit is scheduled to drop to $25,000 for 2014.