Many business owners think they can’t afford to invest in equipment or vehicles for their businesses. But they may be forgetting about the magic of the depreciation deduction, which allows you to subtract the purchase price from your business’s gross income and thereby lower your taxes.
Simply put, depreciation is a way of recovering the cost of a purchase across time, usually over several years. If you purchase a vehicle or piece of office equipment that will last more than a year, you can often deduct its cost over several years. The depreciation deduction is based on the idea that your purchase tends to decline in value over the years, as it gets older and more worn. This deduction recognizes that loss of value.
Depreciation is a complicated concept because changes are frequently made to the federal tax code regarding what business purchases qualify for depreciation and the schedules on which these costs can be depreciated. But it’s worth taking the time to learn about depreciation laws, as the tax laws may make one type of purchase more advantageous than another. Depreciation rules may also make it more worthwhile to put off a purchase until the next year instead of making it in the current year, or vice versa.
For instance, in 2008 the depreciation limit was doubled to $250,000. The ceiling for purchases you could disclose without reducing your write-off was also expanded, from $500,000 to $800,000. Obviously if you were a business owner planning a big equipment purchase in 2007, it might well have made sense to wait a few months and make that purchase the following year.
In addition, a special first-year depreciation deduction was instituted in 2008 to help owners who made more than $250,000 in purchases. The special deduction allowed owners to write off 50 percent of any remaining purchase cost in the year of purchase. Also for 2008, the deduction for cars and trucks purchased for business was greatly expanded. These provisions were then extended for 2009 as part of the American Recovery and Reinvestment Act.
As this example shows, depreciation deductions are constantly changing. Either study up on current Internal Revenue Service rules as you mull business purchase decisions or consult your tax professional for guidance on the best timing for equipment buying, and for advice on whether your proposed purchase will qualify for depreciation.
In some situations you may have the option to write off the entire cost of a piece of equipment in the year of purchase or spread the deduction over five years in the traditional way. Think carefully about which would yield you a better tax savings. If you’re having a bad revenue year and your tax base will be fairly low anyway, it doesn’t make sense to take the write-off all in one lump that year. But if you’ve had an exceptionally good year and are facing an unusually high tax bill, it may be beneficial to go for the one-year write-off.
If you use an item only partly for business, you will be limited by the amount you can depreciate as a business deduction. Also, in most cases if you purchase and then sell equipment within the same year, it will not qualify for depreciation.
Business reporter Carol Tice contributes to several national and regional business publications.