Planning Equipment Purchases to Your Tax Advantage
How to use depreciation and Section 179 asset expensing to deduct the cost of additional equipment for your business
Q: My business is experiencing growth that requires the purchase of additional equipment. Should I buy the required equipment this year, or wait until 2003?
A: You should only purchase equipment, or anything else for your business, when you're ready to use it. However, once you've decided that the need is now, you can take advantage of existing tax law by adjusting the timing of your purchase. For example, if your business anticipates it will have considerable taxable income this tax year (2002), you may want to make your equipment purchase before the end of this year. However, if your tax liability for 2002 is low or even a loss and you expect significant taxable income in 2003, you should wait until early in 2003 to maximize the equipment tax deductions available to offset this anticipated 2003 taxable income.
You may deduct the cost of business equipment, furniture and fixtures beginning with the year that you purchase the equipment and use in your business. Once this purchase has been made, you may deduct the cost of this equipment by electing to use the appropriate combination of depreciation and Section 179 asset expensing. Note: If any of these items are mixed-use, their cost must be pro-rated between personal and business use prior to calculating the applicable business tax deduction.
Equipment, such as copiers, computers and telephone systems, is considered five-year property and depreciated over a six-year period of time. Furniture and fixtures, such as desks, file drawers and mobile phones, are considered seven-year property and are depreciated over an eight-year period of time.
If you wish to accelerate the pace of deducting your equipment, furniture and fixture purchases, you can use "asset expensing" under tax code Section 179. Under Section 179, you are allowed to deduct the cost of equipment, furniture and fixtures purchases (that qualify for Section 179 treatment) in the year they are both purchased and placed into service in your business, up to the current limit, which for tax year 2002 is $24,000 (up from $20,000 for 2001). Any remaining portion of your equipment, furniture and fixture costs that's not expensed under Section 179 may then be depreciated using your choice of appropriate depreciation methods, over the indicated number of years going forward.
To use asset expensing to deduct the cost of your business equipment, furniture and fixtures, you must apply the following rules:
- Asset expensing is only available for equipment, furniture and fixture purchases in the year in which they are both purchased and placed into business service.
- The percentage of business use must exceed a 50 percent threshold for the year in which the item is first placed into service.
- Your asset expense deduction for any given tax year may not exceed your business's net taxable income for that current tax year.
- The cost of equipment, furniture and fixtures that's not deductible in one tax year (because there's no sufficient current year taxable income to offset) may be carried to the next tax year and added to the cost of qualifying Section 179 equipment, furniture and fixtures placed in service in that tax year.
- For each dollar of equipment, furniture and fixture purchase in excess of $200,000 for a given tax year, the $24,000 is reduced (but not below zero) by one dollar. Therefore, a Section 179 deduction is not allowed when these purchases exceed $224,000 for the tax year.
The combination of depreciation and asset expensing provides your business with a powerful tax planning tool. And remember, it's still not too late to take advantage of this tax saving opportunity for the current tax year, 2002.
Note: The information in this column is provided by the author, not Entrepreneur.com. All answers are general in nature, not legal advice and not warranted or guaranteed. Readers are cautioned not to rely on this information. Because laws change over time and in different jurisdictions, it is imperative that you consult an attorney in your area regarding legal matters and an accountant regarding tax matters.
David Meier received an MBA in Finance from Loyola of Baltimore, and spent much of the 1970s teaching business courses; later, he created a consulting group, and for the next two decades, provided accounting and tax services to small-business owners. He is currently the founder and COO of Business Development Coaching, which provides small-business owners with ongoing business coaching and the knowledge and support required to enable them to become truly successful entrepreneurs. Visit his site at www.makeyourlifetaxdeductible.com.