Don’t miss out: The ideal tax deduction for most contracting businesses
Perhaps more than any other type of business, contractors depend on equipment to get work done. That’s why the type of deduction allowed through Section 179 of the U.S. tax code is perfect for them. Section 179 lets businesses deduct the cost of certain types of property from their income taxes as an expense for the year they’re placed into service instead of requiring the costs to be capitalized and depreciated over a long period of time.
The benefit of taking advantage of Section 179 for you and your business is that the faster deduction provides a current year tax benefit that can lead to an immediate increase in cash flow. The good news is that after a period of uncertainty, the deductions covered by Section 179 were extended and expanded late last year. Not only that, Section 179 was finally made permanent, which makes it easier for you and other contractors to plan equipment purchases long into the future.
What types of items are deductible from your business taxes through Section 179? Tangible personal property with an expected life of less than 15 years used for business purposes more than 50 percent of the time they are in operation. The assets can be new or pre-owned. Examples include tools, machinery, business equipment, office furniture and computers — almost everything needed by a typical contracting company to get work done. Business vehicles that weigh more than 6,000 pounds qualify, as well.
Another significant office expense you can deduct through Section 179 is off-the-shelf software. To qualify, your company must finance or buy it outright. It has to produce income for your business. The software should have a defined useful life of greater than one year. The license for the software cannot be exclusive to your company and the software cannot be substantially modified or customized for your firm.
If your business leases equipment rather than buys it, you can also enjoy the benefits of Section 179. If you leverage a non-tax capital lease, you’re allowed to expense the full value of the lease in its first year under Section 179. In addition, you can get a loan to purchase equipment using an Equipment Finance Agreement (EFA) and take the full Section 179 tax deduction, depending on the overall terms of the agreement.
Tip: Leveraging Section 179 with leased equipment could provide a significant boost to your business. The amount you deduct from your taxes will be more than your first year’s lease payments.
Of course, where there’s a tax benefit, there are limits to it. Section 179 comes with many of them.
Section 179 has an expensing limit of $500,000. In addition, the Section 179 deduction is phased-out dollar-for-dollar if your business purchases a total of $2 million in qualifying equipment in a given year. You’re not allowed to use Section 179 if your qualified equipment spending goes above $2.5 million during a single year. In the future, these Section 179 limits will be indexed for inflation.
You can only take Section 179 deductions up to the level of the taxable income of your business. The deduction cannot lead to a taxable loss for your business.
You can’t use Section 179 to deduct the cost of land or any permanent structures including buildings, fences, or parking lots. Standard inventory items do not qualify. You can’t deduct property used outside the United States. Intangible items such as patents, copyrights and trademarks don’t qualify, either.
As mentioned earlier, you must use the property more than half the time it’s in operation for business purposes during the year you purchase it. If you don’t, you can’t claim the deduction. Your deduction could be scaled back for any non-business use of the equipment. In addition, you cannot transfer property from personal to business use and claim a full Section 179 deduction.
Also, if you claim a deduction and your business use of the property drops below 50 percent in any year after you take the deduction, then the expense must be recaptured and become taxable income for the year it happens.
Remember: It’s your responsibility to keep records documenting the business use of your property.
Section 179 expenses can be deducted for Tennessee excise tax purposes to the same extent that they’re deducted on the same year’s federal income tax return. However, you must be aware that if your business does contracting work in multiple states, some have chosen not to follow the federal law. On the other hand, if you do work in certain opportunity zones, you could qualify for higher deduction limits. If your business does work across state lines or in multiple locations, you should seek guidance from an experienced tax professional.
Section 179, if used correctly, can be a valuable opportunity for improving the immediate cash flow of your contracting business. However, it’s important that you ensure you only take deductions for qualified items and follow all the rules. A tax firm that has experience working with contractors can help. Contact us today so we can discuss how to best leverage Section 179 deductions for your contracting business.