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Squeeze More Out Of Bonus Depreciation Deductions

Unless Congress acts relatively soon, “bonus depreciation” soon will go the way of the five-cent cup of coffee and the good ten-cent cigar. This valuable tax break for businesses is scheduled to be wiped off the books completely on January 1, 2013—and probably for good.

Although you might hold out hope of a reprieve for these deductions, right now you have to play the cards you’re dealt. This could be the last year you can claim bonus depreciation, so plan for it accordingly. Making a big purchase this year rather than next year could result in substantial tax savings.

Bonus depreciation has been available to taxpayers a couple of times in the past. In one recent incarnation, 50% bonus depreciation was authorized for the cost of qualified new, but not used, business property placed in service in 2008. (This tax law provision was extended through 2010). For this purpose, “qualified business property” included property with a regular cost recovery (depreciation) period of 20 years of less; qualified leasehold improvement property; and certain software; and water utility property.

As part of the 2010 Tax Relief Act, Congress reinstated and enhanced the bonus depreciation tax break by authorizing: 

  • 100% bonus depreciation deduction for qualified business property placed in service from September 9, 2010, through December 31, 2011, (through December 31, 2012, for certain other types of property); and
  • 50% bonus depreciation for qualified business property placed in service from January 1, 2012, through December 31, 2012.

That’s where we stand now. Barring any new legislation extending or modifying bonus depreciation—and that doesn’t seem likely to happen—you can still seize a 50% bonus depreciation write-off this year if you place qualified property in service before 2013. 

Combine two tax breaks. While bonus depreciation is still available, a business owner can combine it with a Section 179 election to create a powerful one-two tax punch for 2012.

Under Section 179 of the tax code, your business currently can deduct the cost of qualified business property placed in service during the year, up to a specified maximum. For Section 179 purposes, the definition of “qualified business property” is more expansive than it is for bonus depreciation. It includes most types of tangible personal property. The property may be new or used. 

The maximum Section 179 deduction was increased gradually from $25,000 to $500,000 before it was halved and then cut to its current limit of $125,000 (inflation-indexed to $139,000 for 2012). In addition, if the total cost of property placed in service during the year exceeds an annual threshold, the maximum Section 179 deduction is reduced on a dollar-for-dollar basis. This dollar threshold has been adjusted by legislation coordinated with the maximum Section 179 allowance. The reduction begins at a threshold of $500,000 (inflation-indexed to $560,000 for 2012.) 

Not only can you claim bonus depreciation for the same property that qualifies for the Section 179 deduction, you can write off the remaining balance, if there is one, under the regular depreciation rules governed by the Modified Accelerated Cost Recovery System (MACRS). These deductions are claimed in the following order: (1) Section 179, (2) 50% bonus depreciation, and (3) regular depreciation.

Suppose that in 2012, your business buys new computers (considered five-year property under MACRS) that cost a total of $189,000. For simplicity, we’ll assume you don’t buy any other business property this year. Here’s how your deductions break down in three steps:

1. Your business can deduct $139,000 of the cost under Section 179. That leaves a balance of $50,000.

2. Your business can claim 50% bonus depreciation on that $50,000 balance. That amounts to a write-off of $25,000, and leaves a new balance of $25,000.

3. Finally, your business can take a first-year regular depreciation deduction for 20% of the balance. That amounts to a write-off of $5,000.

By taking full advantage of the tax breaks in effect in 2012, your business is able to write off a grand total of $169,000 ($139,000 + $25,000 + $5,000) of the $189,000 cost!

Note that other special rules may limit deductions for cars and other vehicles used in your business. 

Of courses, taxes aren’t the be-all and end-all for small business owners. But you should be aware of the potential tax benefits involving bonus depreciation in 2012.

This article was written by a professional financial journalist for Legend Financial Advisors, Inc. and is not intended as legal or investment advice

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