Tax Incentives for Purchases
As you plan your equipment purchases, keep in mind that Uncle Sam will help you out by letting you deduct some or all of the equipment's cost on your federal income tax return. Your state tax agency may also provide some tax-saving incentives.
Expensing election. Perhaps the biggest tax incentive that's available is your ability to elect to immediately expense (deduct in the current year) the cost of certain equipment you purchase for use in your business. In other words, rather than having to recover the cost for tax purposes over several years via depreciation deductions, you can recover all or a portion of the cost on your return for the year that you start using the equipment in your business. In general, you can expense up to $128,000 in equipment costs for purchases in 2008 (up from $125,000 in 2007). This amount will be indexed for inflation each year through 2009.
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For those affected by hurricanes in the gulf zone, the Gulf Opportunity Zone Bill of 2005, permits small businesses to claim a further deduction for qualifying expenditures made in the disaster area through 2007, and provides partial expensing for demolition and cleanup costs. To qualify, property must be purchased on or after August 28, 2005, and placed in service on or before December 31, 2007.
And thanks to the Job Creation and Worker Assistance Act, enacted March 9, 2002, businesses in the New York City Liberty Zone (essentially southern Manhattan) get an extra first-year deduction of $35,000. This tax break was intended to help businesses and the area recover from the terrorist attacks on September 11 by providing a higher first-year deduction limit than otherwise available (e.g., $24,000 in 2002).
The Liberty Zone expensing election continues to be available for qualified business property purchased in the Liberty Zone after September 10, 2001, and before September 11, 2004, and placed in service by the end of 2006.
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If the equipment is a passenger car, computer, or related peripheral equipment, cellular telephone or similar telecommunications equipment, TV, camera, or stereo equipment, you can't elect to expense the cost of such item (termed "listed property" for tax purposes) unless more than 50 percent of its use is related to your business.
Accelerated depreciation. For tax purposes, you account for the equipment costs that you don't or can't elect to immediately expense through depreciation deductions. To encourage businesses to invest in equipment and other business assets, current federal tax law permits you to claim a greater percentage of an item's cost as depreciation deductions during the earlier years of the item's use.
For example, for equipment like computers that the law assumes has a five-year useful life, you can claim a first year deduction of up to 20 percent of the item's cost, and a second year deduction of up to 32 percent of the cost.
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Properly planning the timing of your equipment purchases can produce significant tax savings. For example, the equipment expensing election applies whether you purchase and start using a given piece of equipment during the first month of your tax year, or the last month.
So, if toward the end of your tax year you're contemplating a purchase of equipment, you may do well to complete the purchase and start using the equipment before the end of the year if you can benefit from deducting the equipment's cost on your current year's tax return.
Timing is also important for depreciation purposes. For the first year that you use an item in your business, you'll usually be allowed to claim six-month's worth of depreciation, regardless of when you actually start using the item. For this reason, there is some benefit to delaying your purchases until the last half of your tax year. However, you don't want to wait too long because if more than 40 percent of your purchases fall in the last quarter of your tax year, the rules change. The MACRS deduction for property is subject to the "midquarter convention." In English that means that if you place an asset into use in during the year, you compute the full year's depreciation and then multiply it by the following percentages, depending on which quarter it was placed in service: First quarter-87.5%, Second quarter-62.5%, Third quarter-37.5% and Fourth quarter-12.5%. Consult your tax advisor for further details as this can get very complicated.
If you're planning one or more major purchases, we suggest you have your accountant "run the numbers" so you can see how different purchase dates can affect your tax bill.
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Under special tax law provisions that no longer apply to most situations, businesses were entitled to take an additional first-year depreciation deduction equal to 30 percent of the value of certain types of qualified property before calculating their normal depreciation deductions. For purchases made after May 5, 2003, the amount of the bonus depreciation jumped to 50 percent. However, taxpayers could still choose to elect out of the bonus depreciation entirely or elect the 30 percent amount instead of the increased 50 percent amount.
Qualifying property includes:
- property with a recovery period of 20 years or less (which really covers just about all types of personal property);
- water utility property (generally a benefit to businesses using equipment for the gathering, treatment, or commercial distribution of water); and
- qualified leasehold improvements to nonresidential real property (except enlargement of the building, installing an elevator or escalator, improvements to common areas, or improvements to the building's structural framework).
The only real catch to the depreciation bonus is that such property must be acquired after September 10, 2001, and before September 11, 2004. Also, the property must be placed in service on or after September 11, 2001, and before January 1, 2005.
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Businesses located in the New York City Liberty Zone (i.e., southern Manhattan) also get the first-year bonus depreciation, except the qualifying provisions are more liberal. The types of property qualifying for the extra depreciation deduction include real property (e.g., buildings) rehabilitated or replaced after the September 11 attacks, as well as used property.
In addition, Liberty Zone businesses are given more time for placing qualifying property in service. Property must generally be placed in service by the end of 2006. In the case of nonresidential real property and residential rental property, such property must be placed in service by the end of 2009.
The Gulf Opportunity Zone Act of 2005, allows businesses in affected areas in the Gulf zone to claim an additional first-year depreciation allowance equal to 50 percent of the adjusted basis of the cost of qualified property acquired on or after August 28, 2005, and placed in service on or before December 31, 2007. Nonresidential real property and residential real property must be placed in service on or before December 31, 2008.
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State tax incentives. The tax laws of most states track the federal laws, so you'll get the same expensing allowance or depreciation deduction on your state tax returns. You should also be on the lookout for other tax incentives. For example, your purchase of certain manufacturing machinery may entitle you to a state income tax credit or a state property tax exemption. Or, perhaps you'll be allowed to make the purchase free of state and local sales taxes. Consult a local tax advisor or your state department of revenue for the most current laws in your state.
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