In addition to regular depreciation, you may have also heard of two other types of depreciation called Section 179 depreciation and bonus depreciation.
Section 179 comes from Section 179 of the United States Internal Revenue Code and allows business owners to depreciate the full cost of personal property assets (no real estate) in the year that an asset is purchased and placed into service in a business.
With Section 179 depreciation there are limitations based on income (the deduction cannot be more than business income or earned income) and the total amount invested in the qualifying property. Qualifying property is defined as tangible assets except real estate (buildings with foundations and any asset built into real estate). Tangible assets are something you can see, feel, move, or touch and they have monetary value. For instance, these assets can be destroyed by fire or flood.
Section 179 also carries a stiff recapture provision. This provision requires a business to recognize the difference in what the depreciation would have been if deducted over the normal useful life and the Section 179 deduction. The difference becomes ordinary income if the asset is sold before the useful life has passed. For example, if you took Section 179 on the delivery van (used in the ‘What Do I Need to Know About Depreciation?’ article) you would need to use it more than 50% in the business for the full 5 years or face the depreciation recapture into your income.
The other type of depreciation is called Bonus Depreciation. This is a special depreciation deduction available in varying amounts and may or may not be available for different years. It generally applies to business assets with a useful life of 20 years or less. Bonus Depreciation allows taxpayers to automatically deduct a percentage of the cost of newly acquired personal property assets in the first year, but without the same recapture issues of Section 179.
How Do I Know When to Use Section 179 or Bonus Depreciation?
If you’re in business, you may have choices regarding which depreciation method, or combination of depreciation methods is most useful when it comes to determining whether (and how) to use Section 179 and/or bonus depreciation. This may require some thoughtful tax planning.
While it may look appealing to deduct the full cost of your assets because of the immense tax savings it provides, it may not be the best use of the depreciation deductions that are available to you. There are several factors to consider such as current income and future income, and whether it is more advantageous to take a larger deduction in the current year, or to spread out the depreciation deduction over several years. For example, if the business was struggling this year, you may want to close business operations and sell your assets. Taking only regular depreciation, instead of Section 179 or Bonus Depreciation, will save you from having extra gain income if you have to sell sooner than expected.
Further, you may want to consider whether you will want to keep an asset in the business for the full useful life required by the IRS and whether the asset is going to decrease in value by the time you sell the asset. For example, if the delivery van could also be used as a minivan and you start having a family, you may want to convert the van fully to be your personal vehicle before 5 years is up. Taking regular depreciation would save you additional taxes when that happens.
