Takeaways
- Understanding depreciation deductions is key when purchasing assets for your business.
- Elections such as Section 179 and bonus depreciation may allow faster cost recovery for eligible asset purchases.
- The tax treatment of an asset depends on whether costs are capitalized or currently deducted, and if capitalized, how they are recovered.
- The nature of the asset, how it is classified, and when it is placed in service all influence the appropriate tax treatment.
When a business invests in new assets, it is not just about enhancing operational capacity or efficiency. It is also about understanding the tax implications that come with those investments. Asset purchases can affect business taxes through depreciation, expensing elections, and timing rules that determine when deductions begin.
As a business owner, it is important to understand how asset acquisitions may impact your tax situation, including how assets are classified, when they are considered placed in service, and which cost recovery options may be available.
Depreciation Deductions
Basics of Asset Depreciation for Tax Purposes
Depreciation is the process of recovering the cost of certain property used in a trade or business over time. For federal tax purposes, most depreciable business property is recovered under the Modified Accelerated Cost Recovery System, commonly referred to as MACRS. Under this system, assets are assigned specific recovery periods and methods based on their classification. An asset generally must be placed in service before depreciation deductions can begin. IRS Publication 946, “How To Depreciate Property,” explains these rules in detail.
Example: Tom purchases a new industrial oven for his bakery at a cost of $10,000. Once the oven is installed and ready for use in the business, it is considered placed in service. Under MACRS, commercial kitchen equipment is assigned a specific recovery period based on IRS classification rules. Tom recovers the cost of the oven over that IRS defined recovery period using the applicable MACRS method and convention, rather than selecting an arbitrary useful life. Each year’s deduction is determined by the MACRS schedule, which may not be the same amount every year.
Various Depreciation Methods and Schedules
Under MACRS, the IRS provides specific depreciation methods, recovery periods, and conventions that apply to different types of property. Common MACRS methods include 200 percent declining balance, 150 percent declining balance, and straight line, depending on the asset type and applicable rules. The recovery period, such as five year or seven year property, is determined by IRS asset classification rather than taxpayer preference. IRS Publication 946 outlines which methods and recovery periods apply to different categories of property.
Example: Sarah owns a printing business and acquires a new printing press. Based on its classification as machinery and equipment, the press falls into a MACRS recovery class determined by IRS guidance. After reviewing the applicable rules in IRS Publication 946, Sarah depreciates the printing press using the MACRS method and recovery period assigned to that class of property. The resulting depreciation deductions are larger in earlier years and smaller in later years, consistent with the applicable MACRS schedule.
Section 179 and Bonus Depreciation
Immediate Expensing Under Section 179
Section 179 allows businesses to elect to expense the cost of certain qualifying property rather than recovering it over time through depreciation. To qualify, the property must generally be acquired and placed in service during the tax year and meet the definition of eligible Section 179 property. The deduction is subject to annual dollar limits and a limitation based on taxable income from the active conduct of a trade or business. Unused Section 179 amounts may be carried forward. IRS Publication 946 and the Instructions for Form 4562 provide current details on these rules.
For tax years beginning in 2025, the maximum Section 179 deduction is $1,250,000, with a phaseout beginning when the total cost of qualifying property placed in service exceeds $3,130,000. Certain vehicles and other property types are subject to additional limits.
Example: Emily’s graphic design firm purchases computers and software costing $25,000 during the year. Because the equipment qualifies and is placed in service during the tax year, Emily may elect to expense some or all of the cost under Section 179, subject to the applicable dollar limits and her business income limitation. If the election is allowed, this reduces her taxable income from the business for the year rather than spreading the deduction over multiple years.
Bonus Depreciation Rules and Eligibility
Bonus depreciation, also known as the special depreciation allowance, permits an additional first year deduction for qualified property beyond regular MACRS depreciation. The percentage allowed for bonus depreciation depends on when the property is acquired and placed in service, and the rate has changed over time. For certain property placed in service after December 31, 2024 and before January 1, 2026, the bonus depreciation rate is generally 40 percent, with special rules for certain long production period property and aircraft. IRS Publication 946 explains the applicable rates and requirements.
Example: Michael’s construction company purchases several new trucks for $150,000 and places them in service during the year. In addition to regular depreciation or a possible Section 179 election, Michael may be eligible to claim bonus depreciation at the applicable rate for the year the trucks are placed in service. Because vehicles are subject to specific substantiation, business use, and depreciation limit rules, Michael must also maintain appropriate records and apply the correct limitations when determining the allowable deduction.
Asset Classification and Tax Impact
Differentiating Between Capital and Deductible Business Expenses
Business costs are generally classified as either currently deductible expenses or capitalized costs. Capitalized costs are associated with assets that provide a benefit beyond the current year and are typically recovered through depreciation or amortization, subject to available elections. Deductible business expenses are usually ordinary and necessary costs that are consumed within the year. The IRS provides guidance on these distinctions and maps business expense topics to current resources through its Guide to Business Expense Resources.
Example: Lisa’s boutique purchases a new cash register and office supplies. The cash register provides benefits over multiple years and is generally treated as a capital asset. Depending on the facts and applicable limits, Lisa may recover its cost through depreciation or potentially elect to expense it under Section 179. The office supplies are used up during the year and are generally deductible as ordinary business expenses.
Tax Treatment Based on Asset Type and Business Use
The tax treatment of an asset depends on both its type and how it is used in the business. Different rules apply to categories such as machinery, furniture, and vehicles. IRS Publication 946 addresses depreciation, Section 179, bonus depreciation, and listed property rules, while IRS Publication 463 focuses on vehicle expenses, recordkeeping, and substantiation requirements. Vehicles may also be subject to annual depreciation limits and business use percentage calculations.
Example: James purchases a delivery van for his floral business and office furniture for his headquarters. The van’s depreciation and potential expensing are subject to rules in IRS Publication 946, including listed property limitations, while IRS Publication 463 outlines the recordkeeping and substantiation required for vehicle expenses. The office furniture is depreciated under the applicable MACRS recovery period for furniture and fixtures. Each asset follows different rules based on its type and business use.
Learn More
Investing in your business through asset acquisition can support growth and efficiency, but it also involves important tax considerations. Understanding how assets are classified, when they are placed in service, and which cost recovery options may apply can help you make more informed decisions.
If you would like to explore how these general tax concepts relate to your business, you are invited to schedule a free consultation with me, Mike Davidov, CPA. Together, we can discuss considerations relevant to your situation.