Do you purchase equipment, vehicles, computers, furniture, or other “capital expenses” for your business or real estate investments?

If so, did you know that you have many options for writing-off your expenses?

How do you avoid losing money by making the wrong choice?

You may not have considered the choices you have for deducting the assets that you buy for your business.

To create some perspective, let’s say you have seven employees who now work at least two days a week from home because of COVID-19. To facilitate this working at both the office and the home, you purchased seven laptop computers at a cost of $2,179 each.

You have five choices for deducting the computers:

1. De minimis expensing

2. Bonus depreciation

3. Section 179 expensing

4. Modified accelerated cost recovery system (MACRS) depreciation

5. Straight-line depreciation

You have four things to consider:

1. What is the maximum you can deduct this year, and what if you want to deduct less?

2. How does this affect your Section 199A deduction if you operate as a proprietorship, a partnership, or an S corporation? (C corporations don’t qualify for the Section 199A deduction. If you operate as an LLC, you are one of the four taxable entities (proprietorship, partnership, or C or S corporation.)

3. If you file as a proprietorship on Schedule C of your Form 1040, is there a self-employment tax issue when you sell the computers?

4. How does your choice affect your local, county, and state personal property taxes?

De Minimis Expensing

Deduction. With de minimis expensing, you deduct $15,253 ($2,179 x 7) if the invoice shows the seven computers, as explained in Act Now! Get Your 2018 Expensing in Place.

The de minimis safe harbor expensing does not allow you to control your deduction. With this method, you deduct $15,253.

When using de minimis expensing, the computers do not show up as assets on your books of account. Think of them as pencils and paper that you expense as office supplies.

Reminder. The de minimis safe harbor allows you to elect immediate expensing of small-asset purchases, provided that

• the asset costs $2,500 or less ($5,000 if the business has an applicable financial statement),

• you reflect the asset cost as an expense on your company’s books of account, and

• your financial accounting procedures follow the same expensing method you use for federal tax purposes.

Section 199A. With de minimis expensing, the computers are not assets in your books of account, so they do not count as assets for the Section 199A deduction. But it’s likely they were not going to do much, if anything, for your Section 199A deduction anyway.

Self-employment tax. If you operate as a proprietorship or an LLC taxed as a proprietorship—and you sell the computers for, say, $4,300—you report $4,300 as ordinary income but face no self-employment tax on the gain.

Personal property taxes. The assessment of property taxes by local, county, and state governments varies widely. Some jurisdictions look to the business’s income tax returns for property that is subject to property taxes.

De minimis expensing removes the expensed property from the tax returns. If your business is taxed based on the property listed on your federal income tax return, de minimis expensing reduces your personal property taxes.

Bonus Depreciation

Deduction. If you don’t expense the computers using the de minimis safe harbor, you must elect out of 100 percent bonus depreciation if you don’t want to use it otherwise you could face unexpected tax when you sell your assets.

Pay attention here. The required bonus depreciation applies on a class-by-class basis to all assets in the class if the class is eligible for bonus depreciation.

But for simplicity here, let’s say that the only assets you purchased this year in the five-year class are the seven computers. With bonus depreciation, your deduction is $15,253.

Section 199A. Property for which you use bonus depreciation adds to your qualified property and can add to your Section 199A tax deduction. To see how, use the 2020 Section 199A Calculator. Self-employment tax. If you operate as a proprietorship or an LLC taxed as a proprietorship—and you sell the computers for, say, $4,300—you report $4,300 as ordinary income but face no self-employment tax on the gain.3 Personal property taxes. If the assessment of your personal property taxes is based on your business’s income tax returns, the assets for which you claimed bonus depreciation show up and could increase your personal property taxes.

Section 179 Expensing

Deduction. Section 179 expensing applies before bonus depreciation, so you could use it to expense all of the $15,253. But if you want to use Section 179 for a lesser amount—say, $5,000—then you need to elect out of bonus depreciation, or you will have inadvertently expensed the entire $15,253 ($5,000 under Section 179 and $10,253 in bonus depreciation).

Example. To use Section 179 to expense $5,000 and then depreciate the remainder using either MACRS or straight-line depreciation, you need to first elect Section 179 for $5,000 and then elect out of bonus depreciation.

Section 199A. Property for which you use Section 179 expensing adds to your qualified property and can add to your Section 199A tax deduction.

Self-employment tax. When the business use of Section 179 property drops to 50 percent or less before its depreciable period expires, you trigger Section 179 recapture. And that recapture income triggers the self-employment tax for the Schedule C taxpayer and a partner in a partnership.

When you sell a Section 179 asset, your gain or loss does not affect your self-employment taxes.

Personal property taxes. If the assessment of your personal property taxes is based on your business’s income tax returns, the assets for which you claimed Section 179 expensing and/or depreciation show up (often in a supporting schedule) and could increase your personal property taxes.

Depreciation

Deduction. If you elect out of bonus depreciation and don’t otherwise expense the computers, you will depreciate the $15,253 using a five-year depreciation table (which, because this is tax law, takes six years). You have two choices for the pace of the depreciation—straight-line or MACRS—as you can see in the table below.

Section 199A. The computers you depreciate add to your qualified property and can add to your Section 199A tax deduction. To see if that happens for you, use the Section 199A Calculator. Self-employment tax. If you operate as a proprietorship or an LLC taxed as a proprietorship—and you sell the computers at a gain of $4,300—you report $4,300 as ordinary income but face no self-employment tax on the gain.

Personal property taxes. If the assessment of your personal property taxes is based on your business’s income tax returns, the assets you depreciate show up (often in a supporting schedule) and could increase your personal property taxes.

Takeaways

With the choices that you have for deducting assets, you can set the stage to avoid losing money to the tax laws. But you need to make sure of your choices in year one.

For example, bonus depreciation is automatic if you don’t elect out. Say you didn’t know about the election, and later you suffer an IRS audit—your taxes are going to change, and not in the way you planned. With our computer example, you have five choices for your deductions:

1. De minimis expensing

2. Bonus depreciation

3. Section 179 expensing

4. MACRS depreciation

5. Straight-line depreciation

If you want to deduct the entire $15,253 in year one, your best choice is de minimis expensing because that simplifies your tax records and may reduce your personal property taxes.

If you want to stretch out the deduction, you have the option of using Section 179 to expense something additional in year one and then depreciating the remainder by using either MACRS or straight-line depreciation. To make this combination work, you need to elect out of bonus depreciation

If you need my assistance or would simply like to discuss your tax savings options, please set up a time to speak here.

~ Chad Pavel, CPA