Whenever property is purchased for use in a business and that property has a useful life of more than one year, its cost must be deducted over its useful life. This accounting procedure is referred to as depreciation. The number of years the property must be depreciated is largely dependent upon the type of property it is, although sometimes the type of business in which it is used also determines its assigned life.
Most business assets are depreciated over a specified life. This is how their cost is deducted. For some assets, the depreciation is straight-line, while for others accelerated methods that front load the deduction may be used. Following is a list of the depreciable lives assigned for some commonly encountered business assets. Assets that are used only partially for business must be prorated by their business use.
Agricultural Equipment 7 Yrs
Automobiles (1) 5 Yrs
Commercial Real Estate 39 Yrs
Land Not Depreciable
Land Improvements 15 Yrs
Office Equipment 5 Yrs
Office Furnishings 7 Yrs
Residential Real Estate 27.5 Yrs
Trucks 5 Yrs
(1) Vehicles under 6,000 lbs. gross unladen weight have additional deduction restrictions.
However, there are exceptions to the depreciation requirement:
Bonus Depreciation – Originally implemented in 2008 to help spur the economy, bonus depreciation allows a business to deduct 50% of the cost of qualified new personal tangible property, certain leasehold property (interior qualified improvements to non-residential property after the building was placed in service) and certain plants bearing fruits and nuts that are planted or grafted before January 1, 2020. However, bonus depreciation is being phased out over a period of years by reducing the percentage allowed:
o 50% through 2017,
o 40% for 2018 and
o 30% for 2019.
Materials and Supplies – The cost of acquiring or producing materials and supplies is deductible in the tax year in which the materials and supplies are used or consumed in the taxpayer’s operations. “Materials and supplies” means tangible property that is used or consumed in the taxpayer’s operations that is not inventory, and that (any one applies; applicable after 12/31/13):
- Is a component acquired to maintain, repair, or improve a unit of tangible property owned, leased, or serviced by the taxpayer and that is not acquired as part of any single unit of tangible property;
- Consists of fuel, lubricants, water, and similar items that is reasonably expected to be consumed in 12 months or less, beginning when used in the taxpayer’s operations;
- Is a unit of property with an economic useful life of 12 months or less, beginning when the property is used or consumed in the taxpayer’s operations;
- Is a unit of property that has a cost or production cost of $200 or less; or
- Is identified in guidance published by the IRS as materials and supplies.
De Minimis Cost Expensing – The de minimis safe harbor rule allows businesses to expense rather than capitalize (depreciate) the purchase of tangible property based on the safe-harbor cost of the item. The amount of the safe-harbor is not a single fixed amount for all businesses, but rather an amount adopted by a business subject to maximum amounts specified in the regulations, depending upon whether a firm has an Applicable Financial Statement (AFS). To adopt a de minimis safe harbor, a business must have an accounting procedure in place before the beginning of the business’s tax year that specifies the business’s de minimis safe harbor. Failure to do so will result in a safe harbor amount of zero and the only items that can be expensed would be those with a useful life of one year or less or those for which the Sec 179 election is made.
- For businesses with an AFS (generally large corporations) the safe harbor amount can be established in a written accounting procedure to be between zero and $5,000.
- For all other businesses the safe harbor amount can be established in an accounting procedure to be between zero and $2,500. While the accounting procedure for non-AFS businesses is not required to be written, it is highly recommended that the business take the extra step and put the procedure in writing.
Sec 179 Expensing – The tax code contains a special provision that allows certain types of property to be expensed (deducted in year of purchase) rather than being depreciated. This provision is commonly referred to as Section 179 expensing and is limited to a maximum annual amount of $500,000. After 2015 the annual limit is subject to an adjustment for inflation, but there will be no increase for 2016. The Section 179 deduction only applies to tangible personal property such as tools, office equipment, machinery, etc., and does not apply to real estate, but see special exceptions below. There are some other restrictions as well, so be sure to contact this office for additional details.
Real Estate Exceptions – The restriction against using Sec 179 for real estate does not apply to qualified leasehold property, qualified restaurant property and qualified retail improvements. Beginning in 2016, air conditioning and heating units are also eligible for Sec 179 expensing.
Caution: The Sec 179 deduction is limited to the taxable income from any active trade or business of the taxpayer(s) including wages. It is also limited if the total cost of property placed into service during the year is over $2 million (adjusted for inflation to $2,010,000 for 2016). If married taxpayers file separate tax returns, special rules apply.
Off-the-Shelf Computer Software – Off-the-shelf computer software is property eligible for Sec 179 expensing.
Example: A small business owner with a retail clothing store could expense under Sec 179 improvements that are made inside the store, such as built-in cabinets to better stock clothing or lights to brighten the fitting rooms. Allowing a retail storeowner to expense these improvements immediately lowers the owner’s cost.