Acquiring capital equipment can be more affordable on an after-tax basis, thanks to Section 179 of the Internal Revenue Code, along with bonus depreciation rules. Those tax incentives also can help to reduce the cost of capital expenditures for companies that lease equipment rather than purchase it outright. That’s because lessors can take advantage of the incentives, enabling them to pass on those savings to lessees.
After 2017, however, bonus depreciation will begin to be phased out, suggesting that companies contemplating large capital expenditures might want to move forward sooner rather than later.
Congress regularly changes tax incentives for capital investment. Today’s rules reflect changes enacted at the end of 2015 under the Protecting Americans from Tax Hikes (PATH) Act. The law allows companies to take an immediate deduction for up to $500,000 worth of capital equipment expenditures annually. The equipment can be new or used. (Most tangible business equipment and off-the-shelf software qualify; the IRS is specific on which kinds do not.)
However, the benefit begins to diminish when a corporation’s capital expenditures, whether on one or multiple purchases, exceed $2 million in a given year. For every dollar that total capital investment exceeds $2 million, one dollar is taken away from the $500,000 ceiling.
That means a company investing $2.2 million in Section 179-eligible capital goods in 2017 would only be able to write off $300,000, since the investment exceeded the $2 million cap by $200,000, and that amount is subtracted from the $500,000 ceiling.
Under this formula, if capital expenditures exceed $2.5 million, the opportunity to take the Section 179 deduction would be eliminated. When possible, therefore, timing equipment purchases to maximize these benefits is desirable.
No ceiling applies to the PATH Act’s bonus depreciation provision, although only new equipment is eligible. The law allows for a 50% deduction for the first year the equipment is owned, with first year and subsequent depreciation amounts based on the MACRS (modified accelerated cost recovery system) depreciation schedule for that category of capital good.
Bonus depreciation phase-out
In 2018, the 50% first-year depreciation deduction will be reduced to 40%, then to 30% in 2019, and eliminated thereafter — unless revived by Congress.
The Section 179 and bonus deduction provisions are not mutually exclusive; a corporation can use both simultaneously. For example, here’s how, in 2016 and 2017, a purchase of a capital item for $650,000 could be treated in the year of the purchase: first, the full $500,000 Section 179 deduction could be taken, leaving a basis of $150,000. Then, with 50% bonus depreciation, a $75,000 deduction also could be taken, leaving a $75,000 basis.
And if the equipment is to be depreciated in 20% increments over a five-year period, an additional $15,000 could be deducted, bringing the total first-year write-off to $590,000 ($500,000 + $75,000 + $15,000). That deduction would save the company $206,500 in federal corporate taxes, assuming a 35% tax rate, cutting the after-tax cost of the purchase to $443,500 — a 32% discount.
When deductions exceed corporate earnings, they can be carried forward.
Lease vs. buy
However, given the time value of money, if a significant portion of the potential deduction must be deferred, a company might decide to lease the equipment instead. If structured as an operating lease, the lessee deducts lease payments, and the lessor claims the Section 179 and bonus depreciation deductions.
Capital goods may also be financed using a capital lease, in which the Section 179 and bonus depreciation deductions remain with the lessee.
Want to learn more? Our experts can assist you in planning for and identifying the most cost-effective means to secure the equipment your company needs to maintain and grow your operations, while maintaining maximum flexibility with corporate capital.