IRS Section 179 Deduction
The Section 179 deduction allows businesses to deduct the entire amount of an asset in the year it was purchased, rather than deducting a smaller amount over a number of years with the depreciation method. The maximum deduction cannot exceed $1,040,000 for the 2020 tax year or the business’s taxable income for the year. To take a Section 179 deduction, businesses must file IRS Form 4562 with their federal income tax return.
When you purchase something to use in your business, that expense is a deduction on your business tax return. But what if you purchase something that is going to be used in your business for years to come, like a computer or a piece of equipment?
Under standard accounting rules, you’d use depreciation to take your deduction. This means that rather than writing off the entire asset as an expense in the year you purchase it, you’d take a smaller deduction spread out over a number of years.
But if you’d rather take the deduction all at once, there’s another option for you: a Section 179 deduction.
What Is Section 179 Deduction?
Rather than using depreciation to take a deduction for an asset over a number of years, you can elect to take a Section 179 deduction to expense the entire amount in one year. This business tax deduction can provide a big benefit to small business owners by reducing their taxable income in the year they buy and place this property into service. Lower taxable income means a lower income tax bill at the end of the year.
Recent changes have made the Section 179 deduction even more beneficial to businesses. The Tax Cuts and Jobs Act updated the deduction by doubling the maximum deduction businesses could take in a year and expanding what is eligible to qualify for the deduction.
Depreciation vs. Section 179 Deduction
How does a Section 179 deduction benefit a small business owner?
Let’s say you buy $35,000 of equipment for your business. This equipment has a useful life of seven years and you depreciate it using the straight-line method. We’ll ignore scrap value in this calculation and just say that by depreciating this equipment, you’ll have a depreciation expense of $5,000 each year for seven years.
This can be a strain for a business because even though they paid $35,000 all in one year, they can’t take a deduction for that full expense in that year. Only taking a $5,000 deduction each year can be challenging to their cash flow in the year they made the purchase.
Section 179 offers an alternative to this scenario. Now, rather than deducing the expense over seven years, you can deduct the full $35,000 in the year you made the purchase, lowering your taxable income for that year. For a lot of business owners, matching their deduction to their cash flow is incredibly helpful.
What Is Eligible for a Section 179 Deduction?
Not every asset that you purchase will qualify for a Section 179 deduction. Qualified assets include:
- Tangible personal property like machinery, equipment, furniture, and computers. It doesn’t include building and land, but it can include things that are attached to a building, like grocery store counters, refrigerators, office equipment, and signs.
- Other property that is an integral part of manufacturing, production, or extraction.
- Livestock plus livestock and horticulture structures.
- Improvements made to nonresidential real property like roofs, HVAC, fire protection and alarm systems, and security systems.
If the asset that you purchase is allowable, to qualify for the deduction it will also have to meet the following criteria:
- It must have been acquired for business use: If you have an asset that is used both personally and in business, it must be used at least 50% of the time for business.
- It must have been purchased: Anything that was given to you or inherited can’t qualify.
- It can’t have been purchased from a related party: You also can’t have purchased the items from a related party, like a sibling, spouse, parent, or grandparent. If you buy a printer from your brother, for example, that doesn’t qualify.
- You can’t lease it to others: Generally, property won’t qualify if you purchase it and lease it to someone else. There are exceptions to this though, like if you lease it for less than 50% of its useful life.
- It must be placed in service: You must actually start using the property to have it qualify for a Section 179 deduction. So if you buy property in December but don’t actually start using it until February of the next year, you can’t take the deduction until the tax year that you actually begin using the asset.
Limits for Section 179 Deduction
In general, you can deduct the full cost of the asset if it meets the criteria of an IRS Section 179 deduction. But like with most things in the tax code, it’s not that simple—there are restrictions. These restrictions are:
Property Value Limitation
The Tax Cuts and Jobs Act doubled the amount businesses are able to take as a Section 179 deduction. In most cases, the maximum Section 179 deduction that you can take as of the 2020 tax year is $1,040,000. But that can be decreased in some cases. If you purchased and began using more than $2,590,000 of Section 179 property in a year, you’ll reduce the $1,040,000 limit by the amount you exceed $2.59 million.
For example, if you have property worth $2.8 million in a year, you’ve gone over the $2.59 million cap by $210,000. The maximum Section 179 deduction you’ll be allowed to take in the year is $830,000 ($1,040,000 – $210,000).
Once you have more than $3.5 million of Section 179 property, the deduction is completely phased out.
Business Income Limitation
Your total deduction can’t be more than your taxable income from active trade or business for the year. If you have $200,000 of Section 179 property to deduct, but your total net income is only $150,000, you can only take a deduction of $150,000.
That remaining $50,000 isn’t lost though. You can carry the remaining deduction forward to the next year.
How to Take a Section 179 Deduction
To elect the Section 179 deduction, you’ll file IRS Form 4562 with your federal income tax return. On this form, you’ll provide a description of the asset, cost, and the amount of the deduction you’re claiming.
For more information on IRS Form 4562, including how to file, check out Fundera’s complete guide.
The Bottom Line
Tax deductions are important to any business owner, as the more you can take advantage, the lower your taxable income will be and the less you’ll owe overall. Section 179 deductions can be a big tax break for small businesses and help lower your taxable income for the year that you make the big purchase.
Before you take a Section 179 deduction, be sure to talk to your accountant to be sure you claim everything correctly and you understand the impact of making this decision. Each business’s situation is different and you’ll want to make sure you’re making the right choice for yours.