Depreciation calculations for tax purposes are a completely different animal than the calculations used to record depreciation for accounting purposes. You can use Straight-Line depreciation to calculate your depreciation expense for tax purposes, but most businesses prefer to write off the highest expense legally permissible and reduce their tax bills by the greatest amount.
In addition to Straight-Line depreciation, two other acceptable IRS methods for writing off assets are Section 179 and Modified Accelerated Cost Recovery System (MACRS). The big advantage of the Section 179 Deduction is that you can write off up to 100 percent of the cost basis of qualifying property. If the property doesn’t qualify, most businesses choose to use MACRS rather than Straight-Line depreciation.
Section 179
Section 179, which gets its name from a section of the tax code, is a great boon for companies. Businesses can write off up to $25,000 in newly purchased property that qualifies for the deduction up to 100 percent of the cost basis of the property. This amount could be increased if Congress changes the law. A law passed in 2012 allowed up to $500,000 for the Section 179 deduction, but it expired at the end of 2013.
The primary reason for this part of the tax code is to encourage businesses to buy new property in order to stimulate the economy. That’s why only certain types of property are included, and there are limits on the amount that can be deducted for some types of property.
Basically, Section 179’s qualifying property includes tangible property such as machines, equipment, and furniture. In addition, some storage facilities qualify, as do some single-purpose agricultural and horticultural structures. All cars and SUVs between 6,000 and 14,000 pounds can’t be fully written off under Section 179.
You also can’t write off property held for the production of income (such as rental property), most real property, property acquired as a gift or inheritance, and property held outside the United States.
You can get full details about Section 179 by ordering a copy of IRS Publication 946, How to Depreciate Property, from the IRS or accessing it online. At the time of this writing, the rules for 2014 were not yet published, because the IRS was waiting for congressional action regarding the limits and rules for Section 179.
Be sure to work with your accountant to determine what’s eligible and how much of the cost basis is eligible for the Section 179 deduction.
MACRS
The most common type of depreciation write-off used by businesses is Modified Accelerated Cost Recovery System, or MACRS. The recovery period shown is the basis for this depreciation method. After you know what type of property you have (three-year, five-year, and so on), you use the MACRS table in IRS Publication 946, “How to Depreciate Property,” to figure out the depreciation expense you can write off.
| Property Class Recovery Period | Business Equipment |
|---|---|
| 3-year property | Tractor units and horses over 2 years old |
| 5-year property | Cars, taxis, buses, trucks, computers, office machines (faxes, copiers, calculators, and so on), research equipment, and cattle |
| 7-year property | Office furniture and fixtures |
| 10-year property | Water transportation equipment, single-purpose agricultural or horticultural structures, and fruit- or nut-bearing vines and trees |
| 15-year property | Land improvements, such as shrubbery, fences, roads, and bridges |
| 20-year property | Farm buildings that are not agricultural or horticultural structures |
| 27.5-year property | Residential rental property, not including the value of land |
Luckily, you can leave MACRS calculations for your accountant to do when he prepares your business tax forms.