What is Section 179?
What is Section 179, and how does it benefit businesses? Section 179 is a tax incentive that allows small businesses to write off the entire purchase price of qualifying equipment in the year it was purchased.
If a business bought a piece of equipment before Section 179, they would have had to write it off over its normal recovery period. For example, if a business purchased $100,000 in equipment that was depreciable over five years, they would only be allowed to write off $20,000 of the price during the year it was purchased, then $20,000 per year for four years after that. This made it difficult for some businesses to purchase the equipment they needed. Now, under Section 179, that same business is able to write off the entire $100,000 the same year the equipment was purchased.
Why was Section 179 created?
The Internal Revenue Service (IRS) introduced Section 179 as an incentive to help small businesses and boost the economy. Companies taking advantage of Section 179 deductions aren't actually paying less taxes, they're just saving money in the year they made the purchase instead of over five or more years. This encourages small businesses to purchase more while not taking away from the overall tax revenue.
What are the limits on the Section 179 tax deduction?
Under the rules from the Small Business Jobs Act of 2010, Section 179 allowed small businesses to deduct up to $500,000 in one year, but the rules have recently changed to raise the cap to $1 million. To be able to deduct the full amount, you can't spend more than $2.5 million in that tax year on qualified property. These caps are indexed each year for inflation since they were increased in 2018. In 2020, the amount that can be deducted is $1.04 million and the allowable amount spent is capped at $2.59 million. These limits are what keep this incentive for small and medium-sized businesses.
Not all business purchases are eligible to be deducted through Section 179. The IRS has requirements that must be met to take advantage of this tax incentive:
- The purchase must be considered "qualified property." This means that it must be tangible, depreciable, and used in the active conduct of business.
- The property must be purchased and put into service in the year the deduction is made. This means any equipment purchases must also be installed. Simply buying something on December 31 does not allow you to use Section 179.
Common examples of qualified property are:
- Heavy equipment.
- Certain vehicles.
- Tangible personal property.
- Office equipment.
- Office furniture.
- Certain improvements to qualified real property.
To be able to claim a Section 179 deduction, the business must have a taxable profit. In addition, a Section 179 deduction can only be made up to the amount of taxable income. For example, if the business has a taxable profit of $50,000 before the Section 179 deduction and makes a qualifying purchase of $100,000, only $50,000 of the purchase is deductible in the first year.
Can Section 179 be used to purchase real estate?
Real estate investors often ask, "What is Section 179, and can I use it for real estate?" Unfortunately, Section 179 does not apply to real property. The recapture period for real property has not changed through Section 179. However, The Tax Cuts and Jobs Act of 2017 has changed the limitations to include some improvements made to nonresidential real property:
- Improvements made to the interior of a nonresidential building.
- Fire suppression.
- Fire monitoring.
- Security system.
Improvements that do not qualify under Section 179 include:
- Improvements that increase the size of the building.
- Elevators and escalators.
- The structural framework of the building.
The key here is that these improvements have to be made after the real property has already been put into service. The deduction doesn't apply when these improvements are done during the construction of the building or before it has been occupied.
Can tenant improvements on a commercial property be deducted?
The Section 179 deduction can benefit commercial landlords when renovating a space for a new tenant. Landlords can spend hundreds of thousands of dollars to improve a space for a new tenant as part of a lease. Under the new Section 179 rules, they can now deduct a lot of the cost of these improvements in the year they were made.
The major limitation with deducting tenant improvements is that it can't be done for new spaces or during construction of the building. If the space was not previously occupied, the landlord will have to follow the normal depreciation schedule.
Jerry Sweet, President of Nxtwall, a demountable wall manufacturer, says that many landlords of office properties choose to use demountable walls as a way to still take advantage of the Section 179 deduction when building out spaces or during new construction.
"Since demountable walls are considered office furniture, property owners often choose to use them when they can't otherwise take the 179 deduction or bonus depreciation for improvements," Sweet says. He explains how important these deductions are to some property owners: "There is a lot of pressure to get the walls delivered and installed before the end of the year. They don't want to lose that tax savings right after spending so much on the construction."
How can Section 179 benefit residential real estate investors?
Investors who own residential rental properties are not eligible to deduct improvements to the property since the real estate is not nonresidential. However, investors whose business is renting properties can take advantage of Section 179 for certain equipment used in that business.
Lawnmowers, computers, office equipment, qualifying vehicles, and trailers may be deducted under Section 179. The key here is that this equipment is purchased for business use.
What vehicles qualify for Section 179 deductions?
Most vehicles designed specifically for business use qualify for the deduction because they are unlikely to be used for personal use. Some of these vehicles include:
- Passenger vans that seat nine or more passengers behind the driver.
- Cargo vans with a fully enclosed driver's compartment or cargo area and no seating behind the driver's seat.
- Heavy construction equipment.
- Over-the-road tractor trailers.
- Ambulances or hearses.
- Taxis and other transport vehicles used solely for transportation for hire.
- Passenger vehicles modified for business with no personal use.
Can passenger vehicles and trucks be deducted with Section 179 if also driven for personal use?
If a passenger vehicle or truck is used for business at least 50% of the time, it can be deducted up to a maximum of $11,160 for cars and $11,560 for trucks. SUVs may qualify for a deduction up to $25,000 if they have a gross vehicle weight between 6,000 and 14,000 pounds.
The rules for deducting vehicles become very specific when they have also been driven for personal use. Page 6 of the Instructions for Form 2106 can help you determine the amount that's allowed to be written off based on the amount of time the vehicle is used for business versus personal use.
How to take a Section 179 tax deduction
If you plan to take advantage of the deduction through Section 179, you should make sure the property you are buying qualifies. You should also consider your overall tax situation to determine if taking this full deduction in the first year makes the most sense. A qualified CPA can help with this. That said, here are the steps to taking the Section 179 tax deduction:
- Make a qualifying purchase of tangible real property or make qualified improvements to real property.
- Put the property in service in the year you wish to take the deduction.
- Follow the instructions, and fill out the worksheet on IRS Form 4562.
- Include Form 4562 with your business tax return.
To avoid any mistakes or costly penalties, you should always use a qualified CPA who is experienced with depreciation and Section 179 deductions. Many purchases may not be specifically listed in any examples, and a CPA will be able to help you determine which ones are eligible.
Section 179 vs. bonus depreciation
People often confuse bonus depreciation and Section 179. They are very similar in that they both allow a business to deduct the cost of qualifying property in the year it was placed into service and they are both used for tangible personal property.
The main difference between bonus depreciation and Section 179 is that bonus depreciation is not limited to a business' taxable income. In fact, even a business that does not have a taxable profit can take advantage of bonus depreciation. If the cost of the qualifying property is greater than the profit, the business can use bonus depreciation for the amount that's not eligible for the Section 179 deduction.
Acme Corp. has a taxable profit of $75,000 in 2020 and purchases $120,000 in equipment.
They can take a Section 179 deduction of $75,000 and then use bonus depreciation for the remaining $45,000.
Before the Tax Cuts and Jobs Act of 2017, bonus depreciation only allowed 50% of the cost of qualifying property to be deducted in the first year. Bonus depreciation is currently 100% but will begin to decline by 20% each year starting in 2023.
Bonus depreciation also does not have the same cap as Section 179. Businesses can take advantage of bonus depreciation for more than $1 million in purchases and can have more than $2.5 million in equipment costs for the year.
Section 179 may sound pointless when businesses can use bonus depreciation, but Section 179 has its benefits. There are reasons a business may prefer to take the full deduction in the first year for some equipment, and Section 179 allows the business to elect each equipment purchase differently. If a business elects to use bonus depreciation, each asset in the same class must also be depreciated 100%.
Using Section 179 for financed or leased equipment
In most cases the full purchase price of the equipment can still be deducted in the first year, even if it is financed or leased. This is a significant benefit to businesses because they can take the full deduction even though they haven't fully paid for the equipment. In fact, in many cases the total tax savings can be more than the amount that was actually paid in the first year. The IRS considers a lease to be a financed purchase, so this does not apply to any rented equipment.
For more details on Section 179 and how other depreciation methods work, you can review IRS Publication 946 for instructions. Information on Section 179 begins on Page 15. The National Association of Tax Professionals has also created a presentation that explains all of the pros and cons of the Section 179 deduction.