Tax Guide to Writing Off Equipment & Capital Improvements
The enacted Tax Cuts and Jobs Act (TCJA) allows for a very generous and simplified process for the writing off of expenses related to buying equipment and claiming certain improvements, rather than depreciating their respective costs over a predefined period of years. If you operate a small business, you should be taking advantage of this new legislation. Quite recently, the NFIB released a report stating that 61% of businesses claimed capital outlay, with spending on equipment topping the list at 43%, vehicles coming in at a distant second with 27% followed by expanded or improved facilities with 16%.
Equipment & Capital Improvements Write Off Instructions
The TCJA offers business owners a plethora of options pertaining to the hows, whats and whens of deducting costs practically instantaneously as a substitute for scheduled regular depreciation, otherwise known as dividing a total write off by a period of years and spreading the costs/expenses over those years. The options, which the offices of Thomas Huckabee, CPA of San Diego, California would like to review with you, can be used if cash is used to make a full payment or if financing is utilized for the purchase as a whole, or for a portion of the purchase.
First-year Expensing Write Off Rules
The regulations surrounding the Section 179 deduction, commonly known as “expensing,” have been drastically widened. Expensing, by law, is an option that must be elected. In the past, expensing has been used for purchasing machinery and equipment, despite whether or not the machinery or equipment is brand new or used. The purchase of off-the-shelf software has also been traditionally expensed. Let’s make it clear that none of these aforementioned stipulations have been altered.
What has happened, as a result of Section 179’s expansion, is that businesses can now expense the costs associated with pre-designated qualified real property. To clarify, applicable pre-designated qualified real property includes:
- Designated Nonresidential Construction Improvements
- These are improvements made following a building’s initial service start date. Ventilation systems, like those used for air-conditioning and heat, are covered, as are those expenses concerning security (think fire alarms) and other security systems (think overall alarms systems.) And, again, these can be additional features paid for after a building has been put into operation. Roofing expenses are also included in this category.
- Qualified Improvement Property
- These are improvements made to the interior of a non-residential property following a building’s initial service start date. As an example, if a business is the owner of a strip mall, it may decide to rewire and upgrade the standards of the strip mall’s internal wiring system. Although limits and parameters exist (see below), a business is allowed to expense those upgrading costs. Please note that the definition of qualified improvement property does not encompass any improvements to enlarge the construction or certain other changes made to a property’s internal framework (think elevator or escalator.)
Section 179 expensing has also been broadened to include tangible property that is personal, assuming that such tangible property is most predominantly used to furnish lodging, usually, that lodging used as an investment but not an investment made by a business. Recall that business deductions have always been covered (or not covered) as qualified costs associated with equipment.
In terms of deduction amount parameters, the expenses related to qualified property are capped at $1 million for the calendar year of 2018 up to $1 million. This is a marked allowable deduction amount increase- a raise from the $510,000 limit imposed in 2017.
Heavy SUVs also have a $25,000 dollar limit for expensing. A heavy SUV, by definition, is an SUV with a gross vehicle weight rating exceeding 6,000 pounds but less than 14,000 pounds. Nonetheless, that $1 million limit phases out after aggregated investments for the year top $2.5 million- a raise from the $2 million limit imposed in 2017. The phase-out period is one of dollar for dollar, making expensing for anything in excess of $3.5 million or more in 2018 not covered. The TCJA does include a clause for an update in the $3.5 million figure for inflation.
These generous dollar limits are not, however, as straightforward as they appear to be. This is because expensing will continue to only be applicable to taxable income. This is especially pertinent to C Corporations; so, if a C corporation purchases $500,000 of capital equipment but denotes a taxable income of $100,000, the C Corporation expensing deduction is capped at to $100,000. Adding to the confusion is the fact that any excess amount over that $100,000 can be carried forward.
Bonus Depreciation Write Off Rules
Commonly referred to as a “first-year allowance”, bonus depreciation is just a different method of writing off the cost of eligible property. The write off must be taken in the year that an item is purchased and put into service. As far as 2018 is concerned, bonus depreciation applies to 100% of the costs associated with the purchase of qualified property. No dollar limit is set and it does not matter if the property is new or pre-owned. Depreciation is also not subject to taxable income limits, as is the case with first-year expensing. Bonus depreciation applies automatically; if a business does not want bonus depreciation to be used, it must opt out of the option.
The TCJA has also been expanded to include qualified improvement property. This is assuming that Congress corrects an apparent oversight with regard to the 15-year recovery time period that had always applied to such purchases of property. This means that bonus depreciation can be utilized for expenses related to television, film and live theatrical productions.
The bonus depreciation clause also allows for the deduction of the full write off of costs associated with heavy SUV purchases, so long as the deduction is taken in the year the SUV is placed into service.
De Minimis Safe Harbor
The IRS-created de minimis safe harbor regulation was created by the government bureau as a business alternative to equipment being treated as a capital asset and subsequently notated on a business’ balance sheet. The stipulation permits a deduction, capped at $2,500 per individual invoice or item as non-incidental supply and material. Please note that qualifying businesses having any applicable financial statements, a recent SEC filing being a good example, can deduct $5,000 per invoice or item.
As the law dictates, a de minimis safe harbor deduction can be taken in one of two years: the year in which these materials and supplies are paid for or the year in which the materials and supplies are consumed. The determining factor for which year is used is the year that is later. For instance, let’s say a 75-room hotel purchase’s 75 hairdryers for its rooms at a cost of $20 per hairdryer and they are placed in each room as they’re purchased. The business can opt to deduct $1,500 (75 * $20) as non-incidental materials and supplies; hence the hairdryers do not become balance sheet asset items.
Thomas Huckabee, CPA of San Diego, California recognizes that many options exist when it comes to writing off property and equipment, especially in light of the TCJA’s ratification. Operating a full-service accounting firm, Tom guides clients through the complicated process of knowing which path to take so a business’ write-offs are optimized.