Section 179: What is it and how do I use it?
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'Tis the Season
Section 179 of the IRS tax code is essentially a form of accelerated depreciation available to small businesses. Business owners that use Section 179 can deduct the full price of depreciable equipment from their taxable income the year they put it to use instead of the traditional method of slowly deducting the cost over the course of the equipment’s lifespan. This is especially beneficial to businesses that lease or finance equipment as they can immediately offset the full cost of their equipment long before they pay it off. Although only those who are the registered owner of the equipment can take advantage, so operational leases and rented equipment DO NOT qualify.
The Devil’s in the Details
Now, before anyone goes running off to buy equipment with the intention of deducting it with Section 179, they should first familiarize yourself with its limits. Yes, unfortunately Section 179 is not a limitless tax break. Luckily for small businesses, most of its limitations are specifically designed in a way that won’t hurt their bottom line. These limitations can be placed in three primary categories: deduction/spending, income, and eligibility limitations.
In the spirit of keeping Section 179 as a tax incentive for small businesses, spending caps are implemented each year to keep larger businesses from taking advantage of the deductions. It works by setting two limits: one for the amount you can deduct that year ($1,050,000 for 2021) and one for the total amount of qualifying equipment purchased ($2,620,000 in 2021). Once you surpass the second limit, your deductions are reduced dollar-for-dollar.
For example, if you purchase $2,720,000 worth of qualifying equipment in 2021, you’ll only be able to deduct $950,000 as $2,720,000 – $2,620,000 = $100,000 and $1,050,000 – $100,000 = $950,000).
One important detail to note is that a business can’t create a net operating loss (NOL) using Section 179. That means a business can only deduct up to its yearly income. Luckily, any deductions that are capped by this limitation can be carried over into the next year if they don’t exceed any other limits.
Finally, there are limitations on what types of equipment are eligible for Section 179 deductions. Generally, you can assume that the stereotypical types of business property/equipment – such as machinery, office equipment, and transport vehicles – are eligible. According to section179.org, the list of qualifying property includes:
- Equipment purchased for business use
- Tangible personal property used in business
- Vehicles weighing more than 6,000 pounds (so long as they’re solely used for business purposes)
- “Off-the-shelf” software (meaning software that’s commercially available such as Microsoft Office)
- Office furniture and equipment
- Property attached to your building that is not part of the structural foundation of the building (such as industrial equipment)
- Equipment purchased for business and personal use (the amount you can deduct will be based on the percentage of time you use the equipment for business purposes).
- Certain improvements to existing non-residential buildings (such as fire suppression, alarms and security systems, HVAC, and roofing)
How to Use it
Once you have a firm grasp of how it works, you’re ready to start electing equipment under Section 179. While it’s too late to purchase or finance qualifying equipment for the upcoming tax season, you can still deduct equipment obtained in 2020. All you need to do is to fill out Part 1 of IRS form 4562. You can follow these instructions or consult a tax professional if you’re confused.