Normally, you can't take a current business deduction for the entire cost of a capital asset in the year you purchase it, because the asset's usefulness to your business will extend beyond the year in which it was purchased. However, there is an important exception to this rule.
A special tax provision allows small businesses the option of claiming a deduction in the first year for the entire cost of such qualifying business assets, up to $102,000 in 2004 (originally $100,000 in 2003 and indexed further for inflation in 2005 through 2007). The 2002 limit was only $24,000 and the substantial increase is due to the enactment of the Jobs and Growth Tax Relief Reconciliation Act of 2003.
Businesses in the New York City Liberty Zone (essentially southern Manhattan) continue to get an additional first-year deduction of $35,000. The Liberty Zone was established by the Job Creation and Worker Assistance Act of 2002 to help the area recover after the September 11 terrorist attacks. This deduction is available for qualified business property purchased and placed in service in the Liberty Zone after September 10, 2001, and before 2006.
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If you fully qualify for the expensing deduction, you can get what amounts to a significant, up-front reduction in the out-of-pocket cost of a needed piece of business equipment. For example, in 2004, if you are a sole proprietor in the 25 percent tax bracket, the net cost of buying a $100,000 piece of machinery is reduced to $75,000. The remainder would then be depreciated like any other type of capital asset. |
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If you want to make use of this election, you must do so on your original tax return for the period, on Form 4562, Depreciation and Amortization, or on an amended tax return filed before the due date for your original return (including any extensions). If you don't claim it, you cannot change your mind later by filing an amended tax return after the due date.
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Among the Business Tools are Form 1040 and Form 4562. They are in Adobe Portable Document Format (.pdf), and you will need the free Acrobat Reader to view and print the file. |
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What qualifies for the election? To qualify for this expensing election, the property that you purchase must be tangible personal property, that you actively use in your business, for which a depreciation deduction would be allowed. The property must be newly purchased new or used property, rather than property you previously owned but recently converted to business use. Also, property you acquired by gift or inheritance does not qualify, nor does property you acquired from related persons such as your spouse, child, parent, or other ancestor or descendent, or another business with common ownership.
Eligible types of property include property that is not a building or a structural component of a building, but is an integral part of manufacturing, production, or extraction, or of furnishing transportation, communications, electricity, gas, water, or sewage disposal services; or a research or storage facility used in connection with any of these processes. It can also be a single-purpose livestock or horticultural structure, or a petroleum products storage facility that is not a building. Beginning in 2003, off-the-shelf computer software is eligible for the expensing election, too.
An air conditioning or heating unit doesn't qualify, however. Neither does intangible property such as a patent, contract right, stock or bond, etc.
The property must be used more than 50 percent for business. If you want to expense property that will be used partly for personal or family reasons (e.g., a home computer that you use for business about 75 percent of the time, and for personal use the other 25 percent of the time), you can expense only the portion of the property's tax basis that corresponds to its percentage of business use.
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If, in any year after the year you claimed the expensing election, you either sell the property or stop using it more than 50 percent in your business, you may have to recapture or "give back" part of the tax benefits that you previously claimed. The recaptured amount is equal to the difference between the amount you expensed, and the amount you would have been able to depreciate under the normal rules.
So, if you think you'll only be using the equipment for a year or two, it may be better to forego the expensing election and avoid the recapture problem. |
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Writing Off Assets in the First Year
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