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Expense It: The Growing § 179 Deduction

The recently enacted Small Business Jobs Act of 2010 includes a number of taxpayer-friendly provisions. Two in particular may be very advantageous to small businesses looking to expand: 1) increased §179 deductions for machinery, equipment, and software and 2) new §179 deductions for qualified real property improvements.

1) Section 179 Deductions: Machinery, Equipment, & Software

Section 179 of the Internal Revenue Code allows some taxpayers (except trusts, estates, and certain lessors) to deduct the costs of new or used equipment, machinery, and some software rather than depreciate it over time. However, deductions under §179 are subject to a yearly maximum. Prior to the enactment of the Small Business Jobs Act, that maximum was $250,000, but it has been increased to $500,000 per year for 2010 and 2011.

Congress designed the increase in the §179 deduction to benefit small businesses as opposed to large businesses, as the name of the Act implies. As such, §179 deductions begin to phase out, dollar for dollar, for those businesses that purchase more than $2 million of §179 qualifying property per year and are not available to those that purchase more than $2.5 million.

If taxpayers have §179 deductions in excess of their taxable innome, the excess can be carried forward to future tax years. For example, if a taxpayer has $300,000 of taxable income and purchases machinery valued at $500,000 in 2010, the taxpayer is limited to deducting $300,0000 in 2010, but will be permitted to carryover the remaining $200,000 and apply it to the businesses' taxable income in 2011.

Because §179 deductions do not need to be pro-rated, i.e. purchases in December are entitled to the same deduction amount as machinery purchased in January, businesses looking to purchase §179 machinery, equipment, or software in the near future, may want to do so before the end of either 2010 or 2011.

There is another incentive for making §179 eligible purchases in 2010 and 2011: beginning in 2012, §179 deductions will be reduced to just $25,000 per year.

2) Section 179 Deductions: Qualified Real Property Improvements

The Small Business Jobs Act of 2010 added qualified real property as a new category of property eligible for §179 deductions. Qualified real property includes: qualified leasehold improvements property, qualified restaurant improvement property, qualified retail improvement property. These qualified properties must also be depreciable, acquired by purchase for use in the active conduct of a trade or business, and not be specific types of ineligible property, i.e. used for lodging, used by tax-exmpt organizations, used by governmental units,  used by foreign persons or entities, or heating and air conditioning units.

Section 179 deductions for real property are significantly more limited than §179 deductions for machinery, equipment, or software. In particular, although the general §179 deduction maximum is $500,000 per year, only $250,000 per year is available for qualified real property improvements. Unlike §179 deductions for machinery, equipment, or software, §179 deductions for qualified real property may not be carried over past 2011.

Even though some restrictions apply to all three types of qualified real property, each qualified type is also subject to additional restrictions, listed below. 

Qualified Leasehold Improvement Property

Qualified leasehold improvements include any improvement to the interior of non-residential real property if the property is occupied exclusively by the lessor (not common areas), is made pursuant to a valid lease, and is "placed in service" more than 3 years after the building was first "placed in service." However, these improvements cannot include: any enlargement of the building, any elevator or escalator, any structural component benefitting a common area, or the internal framework or structure of the building.

Qualified Restaurant Property

Qualified restaurant property includes any improvement to a non-residential building if more than 50 percent of the building’s square footage is devoted to preparation of, and seating for on-premises consumption of, prepared meals.

Qualified Retail Improvement Property 

Qualified retail improvement property includes any improvement to an interior portion of a building which is nonresidential real property if such portion is open to the general public and is used in the retail trade or business of selling tangible personal property to the general public, and such improvement is placed in service more than 3 years after the date the building was first placed in service.

Qualified retail improvement property, like qualified leasehold property may not include:  any enlargement of the building, any elevator or escalator, any structural component benefitting a common area, or the internal framework or structure of the building.

This brief overview of some important considerations associated with §179 deductions is by no means comprehensive. Always seek the advice of a competent professional when making important tax decisions. 

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