IRS Code 179: Why is This Section of the IRS Tax Code So Important for Small Businesses?
Personal TaxesThe federal government passed the Tax Cuts and Jobs Act in 2017 which introduced a series of changes to Section 179 of the Internal Revenue Code. As a result, businesses can claim immediate deductions for equipment acquisition expenses.
Colloquially known as the ‘Hummer Deduction’ or ‘SUV tax loophole,’ the IRS Code 179 enables business owners to claim deductions for the costs of purchasing different types of equipment on their tax returns.
Put simply, you can get up to 100% of the funds you invest in the equipment you need to run your business by the end of the tax year in which you purchased the equipment.
We’ll take you through the nuts and bolts of the IRS Code 179 and show you how to use this section of the IRC to your advantage.
Table of Contents
What is an Immediate Expense Deduction?
The depreciation rules allow business owners to deduct a portion of the funds they spend on equipment from their taxable income.
For instance, you can only claim a certain percentage of the camera gear you bought for your video content production business in a single year. So according to the regular depreciation rules, you have to claim the deductions for this expense over three or five years.
The Immediate Expense Deduction is a tax relief that enables a business to claim the deduction of equipment expenses within the same tax year. This means you can get all or a portion of the money you spent on equipping a video production studio in the year of the purchase.
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Making the election under Section 179 of the IRC on Form 4562 to expense property is the easiest way to get an immediate expense deduction.
Optionally, you can use the same form to claim deductions for amortization and depreciation or supply information on how your business uses vehicles or other properties.
The Tax Cuts and Jobs Act
Although it was controversial at the time it was passed, the Tax Cuts and Jobs Act has delivered over a trillion dollars in benefits to small and large businesses.
This act amended the Internal Revenue Code of 1986 by lowering tax rates for individuals and businesses, making itemized deductions less favorable, and increasing standardized deductions.
TCJA had a major impact on Section 179 by increasing the phase-out threshold to $2.5 million and altering the section’s definition of a property so that taxpayers can opt to ‘include certain improvements made to nonresidential real property.’
The amendments introduced by this act are still in effect. The maximum Section 179 deduction has increased from $1 million in 2019 to $1.16 million in 2023, while the phase-out threshold went from $2.5 million in 2019 to $2.89 million in 2023.
It’s important to remember that TCJA and Section 179 place limits on the maximum deduction amounts taxpayers can claim for certain types of assets. Hence, in 2023, you cannot claim more than $27,000 in deductions for an SUV you purchased for business purposes.
The IRC Section 179 Analysis
Instead of claiming smaller deductions over a longer period, you can elect to expense a property you purchased under Section 179 of the IRC. This applies to the following types of equipment and assets:
- Off-the-shelf software products (non-customized software) and computers.
- Machinery.
- Office furniture and supplies.
- Trailers, forklifts, and other similar types of vehicles that cannot be replaced with a personal vehicle.
Moreover, the TCJA altered the definition of real property so that business owners can claim tax deductions for roof repairs, installation of alarm systems and fire alarms, or HVAC installation in a nonresidential property.
Section 179 allows taxpayers to deduct 100% of the equipment’s value from their taxable incomes if the sum is under the annual phase-out threshold.
In 2023, businesses can claim up to $2.89 million in immediate expense deduction and upgrade from $2.7 million a year before.
Qualifying for the Section 179 Deduction
LLCs, partnerships, corporations, and sole proprietorships can use Form 4562 to claim immediate expense deductions under Section 179. However, you must first meet certain criteria before claiming these deductions.
The equipment you purchase must be used for professional purposes before December 31 of the previous year to qualify for a Section 179 deduction.
Moreover, businesses that spend over $4.05 million on equipment in a year are ineligible to make immediate expense deductions under Section 179.
Software products, vehicles, or other equipment have to be used in professional contexts at least 50% of the time to qualify for Section 179 deductions.
Consequently, you’ll have to multiply the asset’s original value by its business-use percentage to calculate the deduction amount you can claim under Section 179.
Businesses can claim an immediate expense deduction for new or used equipment if they never previously owned a piece of equipment. In addition, claiming Section 179 deductions is also an option if you lease or finance the equipment or property.
Bonus Depreciation and Section 179
TJCA also affected the bonus depreciation that allows businesses to write off a certain percentage of the equipment’s value in the first year of the purchase.
More importantly, businesses of all sizes can combine Section 179 and bonus depreciation claims on their tax returns. Essentially, bonus depreciation gives a business an opportunity to claim a deduction for qualifying assets beyond regular depreciation allowances.
The bonus depreciation percentage has dropped from 100% of the asset market value in 2022 to 80% in 2023.
This trend will continue in the subsequent years as the bonus depreciation percentage is expected to decrease to 60% in 2024, 40% in 2025, and 20% in 2026 before dropping to 0% in 2027.
The adjustments of bonus depreciation regulations introduced by TJCA also affected the equipment’s ownership status.
Prior to TJCA, bonus depreciation was only applicable to new equipment, but the act has enabled business owners to claim bonus depreciation for used equipment.
The only limitation is that the business must use the equipment for the first time, which means you cannot claim bonus depreciation for the equipment you used before you bought it.
Combining Section 179 and bonus depreciation presents a number of advantages for small and medium-sized businesses. Hence, you can get a portion of the money you invested in assets or equipment even if the purchase doesn’t meet Section 179 criteria.
For instance, you’re still eligible to claim bonus depreciation if you spend over $4.05 million on equipment in a year.
The downside is that the bonus depreciation percentage will continue to shrink in the next few years, which is why it only offers a short-term upside to businesses.
Frequently Asked Questions
Taxpayers with self-employed status can make deduction claims under Section 179. Freelancers can use Section 179 to acquire physical or digital tools they need to run their businesses.
Purchasing equipment and property can slow down a business’ early growth potential by limiting its investment capabilities. Section 179 allows businesses to retain their working capital by receiving a full refund of the funds they spent to obtain the necessary equipment.
The recapture rule applies to Section 179 property that isn’t predominantly used for business purposes. If a property isn’t used as a place of business at least 50% of the time before its recovery period expires, you must report the benefit of the Section 179 deduction as ‘other income’.
A business cannot claim a tax deduction amount that exceeds its net taxable income.
Consequently, you must remove all the deductions you’re claiming on a tax return, including Section 179 deductions, to calculate the net taxable income and use the sum to calculate the maximum Section 179 deduction amount you can claim.
Speak to a CPA
Starting a business is never easy.
The IRS Code 179 makes getting a business off the ground a little easier because it enables taxpayers to write off the costs they had to cover to acquire the equipment as business expenses.
Still, you’ll need a high level of familiarity with the US tax system to make the most of the benefits Section 179 of the IRC offers.
Call 866-8000-TAX or visit choicerelief.com to schedule a meeting with a CPA who can help you understand the advantages of Section 179.
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Author:
Logan is a practicing CPA and founder of Choice Tax Relief and Money Done Right. After spending nearly a decade in the corporate world helping big businesses save money, he launched his blog with the goal of helping everyday Americans earn, save, and invest more money. Learn more about Logan.
