United States

How recent changes to depreciation rules affect equipment purchase decisions


Economic conditions the past few years have forced many manufacturers to delay or cut back on equipment purchases. However, Section 179 and bonus depreciation incentives are available that allow manufacturers to write off those purchases far more quickly than would have been possible under previous depreciation limits – in many cases, writing off the entire amount invested in such purchases in the first year. Compared to standard depreciation rules that would have required the purchase price of such equipment to be written off over as many as 20 years, these bonus depreciation options can significantly improve cash flow and make it worth re-evaluating purchases companies were delaying due to market conditions.

Section 179
Section 179 allows taxpayers to write off the entire amount of qualifying purchases in the tax year those purchases are made. The IRS defines qualifying property as:

  • Tangible personal property.
  • Other tangible property (except buildings and their structural components) used as:
    • An integral part of manufacturing, production, or extraction or of furnishing transportation, communications, electricity, gas, water, or sewage disposal services,
    • A research facility used in connection with any of the activities in (a) above, or
    • A facility used in connection with any of the activities in (a) for the bulk storage of fungible commodities.
  • Single purpose agricultural (livestock) or horticultural structures. Storage facilities (except buildings and their structural components) used in connection with distributing petroleum or any primary product of petroleum.
  • Off-the-shelf computer software.

A series of legislative changes passed since 2008 have expanded the Section 179 deduction limit from $125,000 for the 2007 tax year to $500,000 for the 2010 and 2011 tax years. Please note that the Section 179 deduction is schedule to decrease to $125,000 in 2012 – so if you are considering a purchase that would qualify for the deduction, it would be prudent for you to complete the transaction this calendar year, 2011.

The Section 179 deduction was previously an option mostly for smaller taxpayers. For the 2007 tax year, the available deduction decreased dollar-for-dollar for every dollar in excess of $500,000 spent on qualifying equipment. Therefore, businesses making more significant investments in equipment did not qualify. Recent legislation has increased that threshold to $2 million, making the Section 179 deduction an option for a much wider group of taxpayers.

Bonus Depreciation
In addition to the Section 179 deduction, a series of recent pieces of tax legislation have introduced bonus depreciation opportunities in an effort to stimulate economic activity. Under these bonus deprecation rules, taxpayers can opt for either 50 percent or 100 percent depreciation in the year purchases are made and placed in service. Where taxpayers can use the Section 179 deduction for purchases of used equipment, bonus depreciation is available only for purchases of new equipment. However, the $500,000 limit and $2 million threshold discussed above do not apply to bonus depreciation situations, making bonus depreciation an option for even very large taxpayers.

Read the article Accounting Methods & Periods/Federal Credits & Incentives Alert for a more detailed discussion of bonus depreciation concerns.

Cost Segregation Issues
One common opportunity we see manufacturers missing involves the classification of expenses involved in changes to their physical infrastructure necessary to install new equipment. For example, a manufacturer may have to move walls, reinforce flooring or upgrade electrical or HVAC systems to accommodate new equipment. Often, manufacturers treat these as real property expenses, which generally have less favorable depreciation schedules than do equipment purchases. In many cases, however, the costs associated with changes to your infrastructure necessary to accommodate new equipment can be classified as part of that equipment purchase, provided they can be appropriately documented.

Obviously, the final decision on any equipment purchase involves a wide number of variables, most of which have nothing to do with tax, but fully understanding the tax deductions available and the impact they will have on your cash flow will help your organization make more informed decisions.