When Business Property Must Be Depreciated

Whenever property is purchased for use in a business and that property has a useful life of more than one year, its cost must be deducted over its useful life. This accounting procedure is referred to as depreciation. The number of years the property must be depreciated is largely dependent upon the type of property it is, although sometimes the type of business in which it is used also determines its assigned life. However, there are exceptions to the depreciation requirement:

Sec 179 Expensing - The tax code contains a special provision that allows certain types of property to be expensed (deducted in year of purchase) rather than being depreciated. This provision is commonly referred to as Section 179 expensing and is limited to a maximum annual amount. For 2012 the amount is $139,000 down from $500,000 in 2011. However, the Section 179 deduction only applies to tangible personal property such as tools, office equipment, machinery, etc., and does not apply to real estate except in 2010 and 2011 (see below). There are some other restrictions as well, so be sure to contact this office for additional details.

The following are the historical rates for the Sec. 179 expense deduction:

2007 - $125,000(1)(2)
2008 - $250,000(1)(2)(3)
2009 - $250,000(1)(2)(4)
2010 - $500,000 (1)(5)
2011 - $500,000 (1)(5)
2012 - $139,000(1)(5)

(1) Married filing separate can only claim the amount shown.
(2) Enterprise/empowerment zones limit is increased by $35,000. 
(3) One-year increase included in the Recovery Rebates and Economic Stimulus Act of 2008. 
(4) One-year increase included in the American Recovery and Reinvestment Act of 2009.
(5) Two-year increase included in the Small Business Jobs Act of 2010.

Caution: The Sec 179 deduction is limited to the taxable income from any active trade or business of the taxpayer(s) including wages. It is also limited if the total cost of property placed into service during 2012 is over $560,000 (down from $2 million in 2010 and 2011). If married taxpayers file separate tax returns, special rules apply.

Special Real Property Sec 179 Deduction in 2011 and 2010 - The 2010 Small Business Jobs Act temporarily expands the definition of property qualifying for expensing under Sec. 179 for any tax year beginning in 2010 or 2011 to include:

• Qualified leasehold improvement property, 
• Qualified restaurant property, and 
• Qualified retail improvement property. 

Example: A small business owner with a retail clothing store could expense under Sec 179 improvements that were made in 2010 and 2011 inside the store, such as built-in cabinets to better stock clothing or lights to brighten the fitting rooms. Allowing a retail store owner to expense these improvements immediately lowers the owner's cost.

Special Dollar Limitation: No more than $250,000 of the $500,000 Sec 179 deduction limitation can be used for Qualified Real Property.

Example- Business taxpayer places in service, in 2011, $100,000 of equipment eligible for Sec 179 expensing and $350,000 of qualifying leasehold improvements. Assuming there is no income limitation the maximum Sec 179 deduction that the taxpayer can claim for 2011 is $350,000 ($100,000 for the equipment and $250,000 for the qualifying leasehold improvements).

Bonus Depreciation - Businesses are allowed to recover the cost of capital expenditures over time according to a depreciation schedule and the lives listed below. In addition to the increased expensing allowance mentioned above, Congress allows businesses to recover the costs of capital expenditures made in 2008 through 2012 faster than the ordinary depreciation schedule would allow, by permitting these businesses to immediately write off 50% (100% for qualified property placed in service after September 8, 2010 and before January 1, 2012) of the cost of depreciable property with a 20-year or less recovery period (e.g., equipment, tractors, wind turbines, solar panels, and computers) acquired for use in the United States.

Deducting the Cost of Business Assets- Most business assets are depreciated over a specified life. For some assets, the depreciation is straight-line, while for others accelerated methods that front load the deduction may be used. Following are examples of the depreciable life for some commonly encountered business assets. Assets that are used only partially for business must be prorated for business use.

SAMPLE DEPRECIABLE LIVES

Agricultural Equipment 7 Yrs
Automobiles (1) 5 Yrs
Commercial Real Estate 39 Yrs
Land Not Depreciable
Land Improvements 15 Yrs
Office Equipment 5 Yrs
Office Furnishings 7 Yrs
Residential Real Estate 27.5 Yrs
Trucks 5 Yrs

(1) Vehicles under 6,000 lbs. gross unladen weight have additional deduction restrictions.