How Business Assets Effect Your Taxes
As a business owner, you can normally deduct business expenses in the year you incur them, but the rule is different for property you buy that is expected to last more than one year, such as buildings, machinery and furniture. You can't deduct the full cost right away. Instead, you depreciate them, or deduct the cost gradually over a number of years. Property that doesn't wear out, such as land, can't be depreciated.
For many kinds of business property, including computers and cars, special "accelerated depreciation" rules allow you to deduct a bigger share of the cost early on, assuming that an asset will decline in value more in the early years of use. Other assets, such as buildings, are depreciated evenly using a method known as straight-line depreciation.
Now that we have covered the basics, let's look at how you may be able to get the most bang for your buck tax-wise out of your business assets.
First-year Deduction (Section 179 deduction)
A special rule known as the "Section 179 deduction" lets small businesses write off the entire cost of certain depreciable assets in the year they are purchased.
In other words, you get to treat the cost as a business expense (hence "expensing"), such as salary paid or utilities rather than an asset that has to be depreciated over a number of years. Property that qualifies for this tax break includes machinery, tools, furniture, fixtures, computers, software and vehicles. (This special rule often goes by the alias "the Section 179 deduction" to give homage to the section of the tax law that allows it.)
This deduction is limited in several ways:
- Dollar limit. For assets placed in service during the tax year, you can take a maximum deduction of $500,000 for 2016.
- Investment limit. As a way to focus this tax break on smaller businesses, firms whose investment in new property exceeds a threshold amount gradually lose the right to expensing. The investment threshold is $2,000,000 for 2016. For example, if you purchased $2,200,000 of otherwise eligible equipment in the year, you can't expense more than $300,000 ($500,000 expensing maximum minus the excess investment of $200,000).
- Taxable income limit. Your total first-year expensing deduction cannot exceed your business's taxable income. Say, for example, that you bought $25,000 of property eligible for expensing in the year, but your firm's taxable income before taking expensing into account is just $20,000. That means your expensing deduction is limited to $20,000; you can carry over the disallowed $5,000 to next year and claim an expensing deduction then, assuming you have sufficient business income.
Depreciation and expensing for that car or truck you use for business is a little trickier than for other types of business assets because IRS has special rules for vehicles.
No matter how much you pay, the standard depreciation first-year write-off for a new or used car is $3,160 and $3,560 for trucks and vans in 2016. (These figures assume 100% business use.)
Under the bonus depreciation rules, another $8,000 can be depreciated during the first year provided the automobiles are purchased new and not used.
In 2016, passenger automobile depreciation limits are $5,100 for the second tax year; $3,050 for the third tax year; and $1,875 for each successive tax year.
In 2016, truck and van depreciation limits are $5,700 for the second tax year; $3,350 for the third tax year; and $2,075 for each successive tax year.