The Section 179 Deduction Trap
Many Oklahoma small business owners take advantage of the accelerated time frame for depreciation under IRS Section 179. But there are traps that many owners discover too late.
Section 179 Deduction Traps
Section 179 allows business to write off a significant portion of depreciation costs in the year the designated property is placed in service. It can be great tax management strategy to purchase equipment (often times with debt) and offset income for tax purposes. But be aware that there are several restrictions and limitations:
Dollar Amount: The 2015 section 179 limits are $500,000 with total equipment purchased in 2015 not to exceed $2 million. This limit is imposed both on the business AND the individual.
Election: Basic, but you have to actively choose to depreciate the property/equipment – it is not automatic. There may be reasons to not take the deduction (for example, income limitation), so don’t assume it should always be a given.
Income Limitation: Generally, the deduction is limited in a given year by the operating income of the business. An officer’s compensation is generally added back to income for this computation. The excess deduction can be carried forward to future years.
Vehicles: Personal vehicles generally don’t qualify for Section 179 treatment. There is an exception for SUV’s that allows $25,000 (per eligible vehicle) to be used under Section 179.
At first glance, taking advantage of Section 179 seems like a no-brainer. But there are a few traps to navigate:
No Future Depreciation: For a growing business that is buying equipment every year, this is less of a problem. But for those that have leveled out and have no capital equipment needs, the day of reckoning comes the year the purchases stop. In that year, the business has NO depreciation because it was already taken in the year of purchase. Additionally, if the equipment was purchased with debt, the cash out for debt service is still due, causing a non-deductible cash outflow for the business.
Multiple Entities: Having interests in multiple pass-through entities (i.e. S-corporations or partnerships) can literally waste depreciation. For simplicity, let’s assume that you own 50 percent interests in three different entities, and each of them takes the maximum Section 179 allowance. You now have (using 2013 limits) three K-1’s with $250,000 on each, but you’re limited to $500,000. So what happens to the other $250,000? Gone forever. Ouch!
Income Limit: As detailed above, the amount of section 179 depreciation is limited to the operating income of the business. Sometimes it might make sense to not take the 179 depreciation. Normal depreciation is not generally limited by income, which could be used to offset income from other pass-through entities (see Income Limitations above).
We Are Here To Help
As you can see, there can be great benefits to taking advantage of the Section 179 deduction. However, with recent limit changes, it’s important to assess how the changes will impact your options and then plan accordingly. Email us today at email@example.com with a specific question about your company. Contact our offices in Oklahoma City: 405-288-1206 or Tulsa: 918-209-3441 to get the help you need.