Section 179 depreciation and MACRS Depreciation Categories
Section 179 and MACRS are two very important depreciation categories that can allow businesses to rapidly depreciate assets in the first year to enjoy tax saving benefits. This article will cover some of the benefits of Section 179 and MACRS depreciation, and explain some of the new tax benefits that were created under the Tax Cut Jobs Act ( TCJA).
Section 179 depreciation
Small businesses can use Section 179 depreciation to depreciate the cost of purchasing a new property and improving the existing property. Under this method, small business owners can immediately expense a deduction rather than capitalizing and depreciating the asset over a set period of time. The benefit of Section 179 depreciation is that it provides the small business owner with immediate tax benefits, as they can fully deduct the total amount during the first year, rather than spreading this out over multiple years. Moreover, there is flexibility for business owners who choose to rapidly depreciate the asset during the first year, and then gradually depreciate the asset in subsequent years. Section 179 depreciation provides small business owners with a unique combination of immediate tax benefits in the first year and flexibility in subsequent years.
Section 179 can help support small business growth and encourage investments in equipment or other assets used to expand their business. The lower taxes paid in the first year can help to offset the higher interest expense from loans to purchase the equipment or from the cash spent to purchase it. For example, if a business purchased $1 million worth of equipment with a 20-year life, they could immediately deduct the $1 million in the first year. The reduced tax burden during the first year could help to immediately offset the cost of purchasing the machinery or equipment.
What Does and Doesn’t Qualify
Section 179 is limited to certain business items, including cars, computers, equipment, and other machinery. Small business owners need to prove that they use all of these assets, including personal vehicles, for business purposes for the majority of the time. According to the IRS, business owners need to prove that these assets are used for business purposes more than 50% of the time.
Equipment: There is a wide variety of business equipment that is eligible under Section 179. Some of this equipment includes machinery, computers, software, and office furniture.
Vehicles: Small business owners can also use Section 179 to depreciate vehicles, even vehicles they use for personal and business purposes.
There are also certain types of investments that do not qualify under Section 179:
- Investment properties do not qualify. However, certain improvements made to non-residential properties can still qualify.
- Land, land improvements, and other buildings
- Gifts and inheritances
Placed in Service vs. Purchase
Small business owners should note that any asset purchased needs to be placed in service during the same year if the company wants to deduct the full amount on their tax returns. While this may not be an issue for purchases like computers or office equipment, which most companies already begin using immediately, small businesses should closely monitor if they purchase other equipment during Q4 2023. For example, the small business should show that they begin using the machinery or equipment shortly after purchasing it for it to be in service.
Changes under the TCJA
The TCJA made some changes to the calculation of depreciation under Section 179, mainly by increasing the eligible amount and adding new types of assets.The IRS also announced that it would adjust these amounts based on inflation in subsequent years after 2018. As of 2022, the maximum deduction amount is $1,080,000, and the maximum value of the property purchased is $2,700,000. These increases apply to tangible personal property, such as machinery and equipment, as well as qualified real property. Qualified real property can include improvements to nonresidential real property, such as roofs, heating or ventilation systems, and fire, alarm, or security systems.
Types of Companies that can Benefit
These changes under the TCJA can benefit companies in multiple industries. Any company with a large office can fully rapidly depreciate typical office expenses, such as computers or office furniture, during the first year instead of in multiple years. Businesses can also improve their offices, including upgrading the heating, ventilation, and air conditioning. Other types of specific businesses that may benefit include the following:
- Agriculture companies can also benefit by using Section 179 depreciation. For example, certain types of agriculture or horticultural structures are eligible, as well as the purchase of livestock.
- Larger manufacturing companies are also poised to benefit from Section 179 depreciation, as machinery or equipment expenses are eligible for this type of depreciation.
- Real estate agents can deduct expenses used to improve their offices or vehicle expenses. Real estate investors can’t use 179 for investment properties but can use it for property upgrades like roofs, heating, and air conditioning units, for example.
It is also crucial to note that companies that can’t afford to buy new equipment are still eligible to use Section 179 depreciation. These businesses can purchase used equipment or lease the equipment and still be eligible.
Modified accelerated cost recovery system ( MACRS) is a depreciation system that allows the asset to gradually depreciate over a set period. The MACRS applies to any asset put into service after 1986. MACRS is a useful system because it allows businesses to recover the cost basis of an asset and pay lower income taxes in the first year. The IRS has a predefined useful life of an asset and reduced the useful life of certain assets to allow small business owners to enjoy tax breaks.
MACRS is a solid alternative to straight-line depreciation, which gradually depreciates the asset over its life in equal amounts each year. The straight-line method benefits companies that want gradual tax benefits each year. However, it does not allow small businesses to enjoy strong tax benefits during the initial year they purchase the asset.
The IRS provides specific guidelines about how certain types of assets fall into different categories. Each category has a different useful life figure, which businesses use to calculate depreciation when they file taxes.
Under this method, businesses can rapidly depreciate the asset during the initial years and then gradually depreciate it over the remainder of its life. This method provides favorable tax benefits during the initial years to help offset the burden of large purchases. It also provides small businesses with tax benefits in subsequent years. This period can be between 3-39 years, depending on the type of asset.
It is also crucial to note that this system can be applied to tangible assets and other forms of intangible assets. For example, patents are also depreciable just like other forms of physical assets like real estate. MACRS is an excellent system for small businesses that want to invest money in capital assets, especially special types of assets that depreciate over a 3-5 year period.
What is excluded: However, there are still certain forms of intangible assets that are excluded from this category. Examples of intangible assets that are ineligible for MACRs include recordings, films, and other intangible properties.
The IRS has clearly established the useful life of certain types of assets, so small business owners must reference this when deciding how to depreciate an asset when they file taxes.
|Tractors, rental property, and racehorses||3 years|
|Various automobiles, computers, office machinery, furniture, and cattle||5 years|
|Office furniture, fixtures, agricultural machinery, and railroad tracks.||7 years|
|Vessel, tugs, trees, and other agricultural structures||10 years|
|Restaurant property, natural gas distribution line, land improvements, and municipal wastewater treatment plants||15 years|
|Farm buildings and certain municipal sewers||20 years|
|Water utility property and certain municipal sewers||25 years|
|Certain buildings or structures ( 80% of income from dwelling units)||27.5 years|
|Non- residential Office buildings, stores or warehouses with a class life of fewer than 27 years.||39 years|
Businesses must use the information in this table when deciding how to depreciate an asset. Once the small business has determined the cost basis for the asset ( price+ and other expenses like delivery or installation), they can use the information in this table to determine how to depreciate the asset.
Properties with a 3, 5, 7, or 10-year useful life will use the 200% declining balance method, which means that you use 200% of the amount that would be used under the straight-line method. Meanwhile, properties with a 15-year useful life will use the 150% declining balance method.
Small business owners also need to determine the convention, which is used to determine how much they can depreciate the asset during the first year. There are three types of conventions that small businesses can elect to use:
- Mid Month: Under this conversion method, you can start depreciating the asset during the middle of the month, even if you purchased it after this date. For example, you can start depreciating an asset in the middle of the month even if you purchased it on the last day of the month.
- Mid quarter: Small businesses who use this method can claim 1.5 months of depreciation if they purchase an asset at any time during a certain quarter, even if it is the last day of the quarter.
- Half year: The half-year method states that an asset is projected to have been in service for half of the year, regardless of when it was purchased during the year.
GPS vs. APS.
There are two types of systems that small businesses can use, which include the general depreciation system ( GDS) and the alternative depreciation system (ADS). Most businesses use the general depreciation system (GDS) when determining how to depreciate assets.
GDS: The general depreciation system is the most common MACRS used to calculate the depreciation of an asset. This method utilizes the declining balance method when calculating the depreciation of an asset. For example, if the depreciation amount is 25% and the asset value is $100,000, the asset will depreciate by $25,000 in the first year and then by $18,750 (0.25*$75,000) in the second year. In this manner, the business can continue to lower its tax burden by recognizing depreciation and can choose to do this more so in the beginning.
ADS: The alternative depreciation system uses the straight line depreciation method. Businesses may choose to use this method because they believe that it is closely connected to the income generated from the asset. Under this method, the depreciation amount is set based on the life of the asset and salvage value so the asset depreciates by an equal amount each year. For example, a company may purchase equipment for $100,000 with a 9-year life and a $10,000 salvage value. The company could recognize depreciation of $10,000/year each year over nine years.
Most businesses will prefer the GDS, as it is more common and allows for greater depreciation in the initial years. There are some cases when using ADS may be legally required. These cases can include the following:
- Tax exempt property
- Tangible property used outside of the United States
- Farming property
- Listed property in a qualified business use ( 50% or less)
Differences in financial statements
Another important fact to note is that the depreciation calculated under MACRS is used to determine income tax paid and is not used in the company’s financial statements. The depreciation methods in the company’s financial statements will likely use other standard forms of depreciation, such as straight-line depreciation.
Both MACRS and Section 179 depreciation can be used to help businesses find a depreciation method that can lower their income taxes during the initial years of the asset’s life. These methods can be superior to the straight-line depreciation method, which depreciates the asset in equal amounts each year. The TCJA has provided many benefits for small businesses by reducing the useful life of certain assets ( MACRS) and increasing the amount eligible for Section 179 depreciation.
Categorised in: Real Estate
This post was written by Sean Allaband