According to Section179.org, the Section 179 2016 deduction limit is $500,000. This is the amount of new or used equipment (or off-the-shelf software) you may purchase, put into service and write off as a direct deduction to your income this year. What’s bad about that? Nothing is bad, specifically. What’s bad is the way you PAY for the equipment. IF you purchase equipment and PAY CASH for it in 2016, then, by all means take the deduction. But if you borrow money to buy the equipment, then you need to realize that Section 179 SAVES YOU NO MONEY in the long-run.
Huh? In simple terms, when you buy equipment you may depreciate (recapture your investment) according to the Internal Revenue Service’s Modified Accelerated Tax Recovery System (MACRS) which means you offset income OVER TIME. In real simple terms, should you purchase $100,000 in equipment and write it off over five years (it’s more complicated than this), then you would depreciate about $20,000 per year (more in early years and less in later years or $100k / 5). So, if you pay cash, you are out $100,000 in year one and write off only $20,000 in year one depreciation. Then your year two through five depreciation deductions eventually catch up and you have deducted $100,000 over a five year period (you do this via the MACRS system – my example is simply straight line deduction for illustration purposes).
But IF you BORROW the money in year one ($100,000) and deduct the entire $100,000 in year one while only paying out $20,000 in cash (again, assumes a straight line payback of $20k per year x 5 years and no interest to keep things simple), then your year two through five payments of $20,000 have no offsetting expense deductions leading one to exclaim, “If I’m making all this money, how come I have no cash?”
That’s because you expensed the entire offsetting depreciation deduction in year one. Remember, the equipment vendor said you would “save taxes?” Well, you did in year one. Cash out $20,000 but you reduced your income $100,000 which reduced your tax liability (depends on your bracket, but if income tax is 33% then your $100,000 is worth $33,000 in tax savings when you paid out only $20,000 cash).
So, IF YOU PAY CASH FOR EQUIPMENT, then deduct it this year using Section 179. If you BORROW money for the equipment, then you are better off matching your depreciation deduction more closely with when the cash goes out.
The Depreciation Problem with Section 179
The vendor-induced panic to buy equipment at the end of the year often results in us buying equipment we don’t need or equipment which hasn’t been proven.
Here’s an expanded explanation from my 2011 alert to you ….
Section 179 Accelerated Depreciation in the U.S. does just that. It does allow you to accelerate or move your depreciation deductions you would take during out years to this year, but it provides NO ADDITIONAL deduction. Over time, you have exactly the SAME tax effect.
Okay, you might be thinking, “What is wrong with taking the depreciation this year instead of waiting?” Follow the cash to find out.
If you pay little or no money down to purchase $50k of equipment this year, you probably can deduct the amount as an expense and reduce the amount of income tax paid this year. “Well, isn’t that saving money? No, because there’s always next year.
Next year you still have to repay the loan (cash out) but you have NO offsetting expense deduction (depreciation). So, we get upside down in our car payment, so to speak. We pay out $12,500 of cash to repay the loan in out years and have $0 of expense deductions, which means we pay MORE taxes in the out years, precisely when we have less cash available because we’re making payments as well as having to pay taxes on the additional income created by having no depreciation deduction. Had we delayed the deduction (not taken Section 179), our depreciation expense deduction would roughly offset the cash out.
What should we do? Again, follow the cash. If you pay cash for equipment, then take the Section 179 deduction. If you finance, however, you are better off deducting depreciation normally. This is especially true with companies that have little money rather than a lot of money.
That way you will have less of those confusing moments when the accountant says you made a lot of money, yet you are wondering where in the world is the cash.
A more detailed synopsis of Section 179 from may be found at Section179.org
For more details on limits and qualifying equipment, as well as Section 179 Qualified Financing, please read that entire website carefully. Again, it is http://www.section179.org
Tom Crouser
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