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With year-end approaching it is time for dentists to think about making equipment and technology purchases if they want to expense (depreciate) those assets on their 2016 tax return. While the rules for depreciating equipment have changed dramatically, one thing remains constant. Equipment must be “placed into service” before any depreciation may be taken.
With year-end approaching it is time for dentists to think about making equipment and technology purchases if they want to expense (depreciate) those assets on their 2016 tax return.
While the rules for depreciating equipment have changed dramatically, one thing remains constant. Equipment must be “placed into service” before any depreciation may be taken. Planning ahead with a Dental CPA can save dentists and their equipment vendors a lot of stress at year-end and ensure that this important rule can be properly adhered to.
In case you missed it, on December 18, 2015, Congress passed and the President signed into law the "Protecting Americans from Tax Hikes (PATH) Act of 2015.” You can read about the legislation in the January 20, 2016 edition of Dental Practice Management in my article entitled, What Dentists Need to Know About Taxes in 2016.
Depreciation is a deduction designed to enable business owners to recover the cost of equipment and certain other property used in their trade or business. It is an annual allowance for the wear and tear, deterioration, or obsolescence of that property. The concept goes back to the industrial age for accounting purposes. Early corporations – largely the railroads – needed a way to report positive income to attract investors. By spreading the cost of capital assets over time instead of reporting the expense in one year, corporations were able to report more consistent profits. Then, in 1913, along came income taxes.
There are dozens of formulas for calculating depreciation for tax purposes and various kinds of property are assigned different useful lives over which they are depreciated. Dental equipment and technology are typically depreciated over 5-years. Furniture and fixtures (dental cabinets) 7-years; certain (qualified) leasehold improvements 15-years; and other improvements including buildings & structures (not land) are depreciated over 39-years. Timing is important in the selection of a depreciation method. If more than 40% of one’s annual expenditure for tangible (depreciable) property is placed into service after October 1st of a calendar year, the amount of depreciation allowed for that year is severely limited. Planning one’s expenditures over the course of a year is critical and may include the use of accelerated methods for calculating depreciation.
2. Section 179
Of particular interest to dentists and their vendors was the reinstatement of and making permanent the $500,000 expensing limit on Internal Revenue CodeSection 179 depreciation. While most dentists would not need to accelerate depreciation to this extent, it is nice to know that a large amount may be deducted if it make good business and tax sense. For example, if a dentist purchases new technology such as a computer system, digital radiography – X-ray machines, sensors, etc., for $80,000, and has to spend $20,000 for cabling and installation, she may deduct the full $100,000 this year under Section 179. Alternatively, to manage her tax brackets and maximize the benefit of the deduction, she may chose to take $25,000 of Section 179 and depreciate the remaining $75,000 over 5-years. Why waste the deduction in a 25% or 28% tax bracket if you know you will be in the 35% or 39.6% brackets going forward? Speaking of tax brackets, Section 179 may not be used to create a taxable loss in one’s business. If a dentist’s net income is $50,000 and they elect Section 179 of $100,000, then $50,000 is utilized this year bringing the net income to zero, and the remaining $50,000 is carried forward and deducted the following year, to the extent there is taxable income, as opposed to being written off over 5-years. Another limitation may exist for dentists practicing in corporations. Section 179 depreciation, and taxable losses, are only deductible in corporations to the extent that corporation has “basis” or equity. Here is the math:
Dr. White’s Corporation:
Beginning Retained Earnings $ 50,000
Add: Net Income 100,000
Less: Distributions - 80,000
Ending Retained Earnings $ 70,000
Section 179 Election 25,000
Remaining Basis or Equity $ 45,000
Dr. White has no problem with basis and may deduct $25,000 under Section 179. Then there is Dr. Black who takes excessive distributions from his corporation:
Dr. Black’s Corporation:
Beginning Retained Earnings $ 50,000
Add: Net Income 100,000
Less: Distributions - 160,000
Ending Retained Earnings $ -10,000
Section 179 Election 25,000
Remaining Basis or Equity $ -10,000
Dr. Black’s Section 179 deduction is not allowed and will be carried forward until there is sufficient basis.
Equipment vendors express frustration with dentist’s CPA’s who tell their clients that they can’t take Section 179. The conversation usually stops there and the sale is lost. A dental CPA will explain the concept to their client and the vendor and point out alternative methods for depreciating equipment because they understand the benefit of incorporating new assets and technology into a practice.
3. Bonus Depreciation
Also included in the PATH act was the reinstatement of Bonus Depreciation. Through 2017, 50% of eligible expenditures may be deducted but, going forward, it will be 40 percent in 2018 and 30 percent in 2019 after which Bonus Depreciation goes away. Bonus depreciation came about after 9/11 and it was limited to the areas in New York impacted by the devastation to help business rebuild. At its inception, bonus depreciation was 30%. The allowance has gone up (and down) over the years due to various tax stimulus packages.
Bonus depreciation is available for qualified property that meets the following requirements:
· New depreciable assets with a recovery period (useful life) of 20 years or less, “off the shelf” computer software, qualified improvement property (39-year depreciation) and qualified leasehold improvement property (15-year depreciation);
· Original use must begin with the taxpayer; and
· Placed in service before Jan. 1, 2020.
Unlike Section 179, bonus depreciation may be used to create a taxable loss but, as pointed out above, dentists practicing in corporations must have basis in order to deduct a taxable loss.
The Path Act created the qualified improvement property category to make certain improvements eligible for bonus depreciation. Qualified improvement property is any improvement to an interior portion of a building that is nonresidential real property if the improvement is placed in service after the date the building was first placed in service. Qualified improvements do not include: 1) enlargements; 2) elevators/escalators; and 3) internal structural framework. Qualified improvements do not need to be pursuant to a lease.
The Path Act changed the rules for depreciating qualified “leasehold” improvement property giving such improvements a 15-year useful (depreciable) life. Qualified leasehold improvement property is any improvement to an interior portion of a building that is nonresidential real property and placed in service more than three years after the date the building was first placed in service. The landlord and tenant cannot be a related party and the improvements must be made pursuant to a lease. In other words, if a dentist owns the real property in which the practice is located, 15-year depreciation on leasehold improvements is not available and the 39-year method must be used.
Regardless of whether one takes Section 179, Bonus, or regular depreciation on new assets, those new assets must be “placed into service” before a deduction may be taken. Placed into service means just what it says; if you want to write off your new computers and digital radiography equipment, you have to be using them on patients. When assets are paid for has no bearing on whether they are depreciated in one year or the next. Also important to note is that Section 179 and regular depreciation may be taken on business assets whether they are new or pre-owned. To take advantage of Bonus Depreciation, assets must be new, meaning that their first use must be with the taxpayer taking the deduction. It is also important to note that not all states comply with federal regulations for Section 179 or Bonus Depreciation. Check with your Dental CPA member of the Academy of Dental CPA’s which consists of 28 firms nationwide. www.adcpa.org