Accelerated Depreciation for Business Tax Savings
Accelerated Depreciation Benefits to Businesses
The 2017 Tax Cuts and Jobs Act made changes to extend several accelerated depreciation benefits for businesses:
- A permanent $500,000 limit on Section 179 deductions will allow businesses to plan for asset purchases and expense purchases immediately instead of depreciating over a period of time. This increased limit will be effective for 2015 business purchases and future years.
- A five-year extension of bonus depreciation as an incentive to businesses for purchasing new equipment. The bonus depreciation amount will be at 50% for 2015, 2016, and 2017, reduced to 40% for 2018 and 2019.
As noted by Tony Nitti at Forbes, the certainty of knowing the limits on these accelerated depreciation benefits in the future allows businesses to "finally act with some certainty over the coming years about the availability of a wide range of tax benefits."
How Accelerated Depreciation Works
Accelerated Depreciation is an important concept for business owners to understand. While it is fairly complicated, and the details and tax implications should be left to an attorney or CPA, you (the business owner) should have an understanding of accelerated depreciation and how you can save on taxes by using it.
First, review the concept of depreciation, which spreads the expenses of an asset over its useful life. Ordinary (un-accelerated) depreciation is also called "straight-line" depreciation because the depreciation expense is the same each year. For example,if an asset is purchased for $10,000 and its useful life is 10 years, under straight-line depreciation, $1,000 would be expensed in each year.
But the useful life of many business assets doesn't follow a straight line. So the IRS allows accelerated depreciation, which puts most of the expense of the asset in the first years it is used. Depreciation on autos, for example, is accelerated. Section 179 deductions are an example of accelerated depreciation provisions set up by the U.S. government to encourage expenditures on capital assets.
Section 179 Deductions and Bonus Depreciation
In recent years, two types of accelerated depreciation have been allowed by U.S. law. These ways to accelerate deductions on business asset purchases are:
- Bonus depreciation is set up to allow a 50% bonus on the amount of expense allowed in the first year a NEW (not used) business asset is put into service (used).UPDATE: Bonus depreciation is available for 2018 tax returns and future year returns, as noted above.
- Section 179 deductions are set up similarly to bonus depreciation but they can be on used equipment or vehicles. Read more about considerations in taking Section 179 deductions. Update: Effective with 2018 business tax returns, Section 179 deductions have been made permanent, as noted above.
Two Ways to Accelerate Depreciation Deductions
The two most common methods of accelerating depreciation are "sum of the years' digits" and "double declining balance." Here is (briefly) how each works:
- Under double declining balance, the asset is depreciated twice as fast as under straight line. Using the example above, 10% of the cost is depreciated each year using the straight-line method. Doubling the rate would mean that 20% would be depreciated each year, so the asset would be fully depreciated in 5 years, rather than 10.
- Under sum-of-the-years-digits, the asset is depreciated faster than straight-line depreciation but not as fast as declining balance. As an example of how this method works, let's say an asset's useful life is 5 years. Adding up the digits would be 5+4+3+2+1 or a total of 15. The first year, 5/15 is expensed; the next year 4/15 is expensed, and so on. So if the asset's cost is $1000, 5/15 or $333.34 would be expensed the first year, $266.67 the second year, and so on.
Using MACRS for Accelerated Depreciation
The IRS currently requires businesses to use the MACRS system for accelerated depreciation, in which asset classification determines the depreciation period.
Discuss with Your Tax Professional
Depreciation calculations are complicated and there are many limitations and exclusions. Be sure to talk to your tax professional before making any decisions about purchasing equipment and completing IRS tax forms.
Disclaimer: This article and the information on this site is intended for general information only. The author is not a CPA, tax attorney, or Enrolled Agent. Each business situation is different and taxes and regulations change often. Consult your tax professional before making business decisions that could affect your tax situation.
Back to All About Depreciation