Tax season is over, but it's never too early to start preparing for the next one. Let's talk a little bit about tax planning and how electing Section 179 of the Tax Cuts and Jobs Act or "TCJA" can be more of a doozy than you think if not taken correctly.

You may have seen a lot of buzz about the Section 179 deduction on social media. But there's one factor that often goes unmentioned - depreciation recapture. This occurs when writing off the entire value of your assets and then selling them after utilizing the Section 179 deduction or retiring the asset before its useful life. Understanding recapture and its impact on asset expensing is key to making the best decisions as a business owner.

What is Section 179 and How Does it Affect Your Business?

Section 179 is a provision that allows small businesses to deduct the entire purchase price of qualifying equipment or software from their gross income. This encourages taxpayers to invest in their businesses by purchasing necessary equipment while alleviating some of the tax burdens that small businesses face.

What does the IRS consider qualifying property or software?

Per IRS Publication 946, a qualifying property has to have the following:

• The property is tangible, such as machinery and equipment. The TCJA was amended to include improvements to nonresidential tangible property that would typically be capitalized such as roofs, air conditioning units, and fire and security alarm systems.
• Must be owned by the taxpayer and used in their regular course of income-producing business
• A determinable useful life that is over 1 year.

Tangible property includes physical assets like vehicles, buildings, and equipment that last over a year. The IRS has set standard useful life spans for nearly all assets. Some examples are furniture and equipment's useful life of 5-7 years and buildings up to 27.5 years. The max deduction is $1M, with a phase-out limit of $2.5M.

Depreciation Recapture

Depreciation recapture is when the IRS asks you to pay taxes on the amount you claimed as a deduction but didn't actually deduct over time. For example, if you bought a vehicle over 6,000 lbs for $100,000, deducted it under section 179, and sold it after a year, you might owe taxes on $80,000.

While leveraging the Section 179 deduction can offer tax savings and facilitate business investment, it's crucial to understand the potential tax consequences associated with selling the asset prematurely. The gains from such sales are taxed based on one's current income level. If income has substantially risen since the asset was put into service, the benefits of the initial tax savings may be outweighed by the recapture amounts. By carefully considering the asset's useful life and reinvesting the proceeds into a qualifying asset, you can minimize depreciation recapture and sustain your business growth.

Sometimes the best move could be to depreciate the asset using the primary depreciation method, MACRS.

There's so much more to take into consideration when deciding how to treat your assets and potential disposals. If you need a hand, we're more than happy to help you out! Just drop us a line and let's take a look at your tax situation together. Don't hesitate to contact us!