Capitalization of costs is the usual practice that any business has to follow when they buy an asset which is supposed to render service for more than a year (usually for fixed assets). In simple terms, that means the cost of the asset is written off in the balance sheet over a number of years. There are rules and laws of depreciation & amortization in place on how to do this actually and it depends on the type of asset acquired.
Capitalization rules are universal and apply to every asset that incurred a cost to the company even if the cost is meager. But there are rules by which you can accelerate the write-off process for each and every asset that is purchased.
Section 179 Deduction
As per this rule, instead of applying depreciation allowances spread over five years or more now you can deduct the cost of the asset (machinery/equipment) in the same year you buy them. For this expensing rule (Section 179 deduction) the dollar limit is set to $500,000 for the year 2015 and 2016. Taking inflation factor into consideration the dollar limit can go up for 2017.
Expensing rule (Section 179 deduction) will prove to be beneficial for businesses that are profitable for the accounting year and it applies to both new and pre-owned purchases. This also means that expensing rule shouldn’t be used to create or increase the net operating loss of the business for the accounting year. Apart from office machinery, laptops, cell phones, furniture the expensing rule can be applied to the purchase of –
- Packaged software bought in the year 2015.
- Put to service after 2015, Air conditioning and heating units and other office utilities.
Apart from Expensing rule (Section 179 Deduction), Bonus Depreciation is another tax write-off method available.
It is a method to accelerate the rate of depreciation deduction. It states that 50 percent of the cost of the item can be deducted for the year when the item is put to service. The 50 percent ceiling applies for the year 2015, 2016 and 2017. For the year 2018, the ceiling goes down to 40 percent and further goes down to 30 percent for the year 2019. It is said that this rule will expire by 2019.
Unlike Expensing rule (Section 179 Deduction) which can be applied to both new and pre-owned purchases, Bonus Depreciation applies to only new purchases only. That said Bonus depreciation for the year 2015 was to be applied for all the machinery, office equipment, and buying of qualified leasehold improvements. Restaurants and Retail property improvement doesn’t qualify for Bonus depreciation method as per the rule. From 2016, Bonus Depreciation can be applied to all qualified improvements made to the commercial premise.
For a fairly expensive item, Bonus Depreciation can be combined with Section 179 along with regular depreciation rules. This means that for highly expensive item purchase you would be able to write-off most of the cost upfront.
You may find more info about various tax write-off methods here: IRS Publication 946, How to Depreciate Property.
De Minimis Safe Harbor
Safe Harbor is another method wherein you instead of using expensing and depreciation methods to write-off, you treat the asset purchasing as material and supplies. In this method, you can deduct the cost of the acquisitions immediately but you cannot add them to the balance sheet.
The safe harbor method for 2015 is limited to $500 per purchase or invoice. For the year 2016, the limit is increased to $2,500 per item purchase.
For to use the Safe harbor method, you need to first attach an election statement with your return. An election has to be clearly made each year stating that you would like to use this method.
You have various methods available at your disposal to write-off expenses of your business related purchases. Also, the method with which you pay for the expenses does not impact your tax write-offs. That is, purchasing using a credit card or cash the capitalization write-offs starts when you bought it and not on how you bought it.