Depreciation, Section 179, and Bonus Depreciation: A Small Business Primer

When a business buys a $4,000 laptop or a $60,000 van, the tax question is not only "is it deductible?" but "when?" Tax law generally requires spreading the cost of long-lived assets over their useful lives. Several provisions let small businesses speed that up. Understanding the toolbox helps you plan and helps you avoid mistakes that come back years later.

Capitalize or expense?

Costs are either expensed (deducted in the current year) or capitalized (recorded as an asset and recovered over time). Repairs and maintenance that keep property in ordinary operating condition are generally deductible. Costs that improve property, extend its life, or adapt it to a new use are generally capitalized. Purchases of equipment, vehicles, furniture, and buildings are capitalized as fixed assets, unless a specific rule allows immediate expensing.

Depreciation basics

Depreciation is the annual deduction for the wear and tear of business property. For most business property, federal tax law uses the Modified Accelerated Cost Recovery System (MACRS), which assigns recovery periods by asset class:

3, 5, or 7 years for many equipment and vehicle categories (5 years for computers and cars, 7 years for office furniture, for example).
15 years for certain land improvements and qualified improvement property in some cases.
27.5 years for residential rental buildings.
39 years for nonresidential real property.

Land is not depreciable. Conventions (half-year, mid-quarter, mid-month) determine how much depreciation you take in the first year. Businesses report depreciation on Form 4562.

Section 179 expensing

Section 179 lets a business elect to deduct the cost of qualifying property in the year it is placed in service, instead of depreciating it. Qualifying property generally includes tangible personal property used in a trade or business, certain software, and some improvements to nonresidential real property. Key features:

Annual dollar limit on total Section 179 deductions, and a phase-out threshold when total qualifying purchases exceed a stated amount. Both amounts are adjusted periodically and were raised by recent legislation, so check current-year figures.
Business income limit. The deduction generally cannot exceed the taxable income from the active conduct of the business, with the excess carried forward.
Business use requirement. The property must be used more than 50 percent for business, and the deduction is limited to the business-use percentage.
Recapture. If business use falls to 50 percent or below, or you dispose of the property, some of the deduction can be recaptured as ordinary income.
Vehicle limits. Certain SUVs and other vehicles have lower caps, and passenger cars are subject to luxury auto limits. See vehicle deductions.
State differences. Some states do not follow the federal Section 179 limits.

For pass-through entities, the deduction is computed at the entity level, subject to limits at the owner level.

Bonus depreciation

Bonus depreciation is an additional first-year deduction available for qualifying property. The percentage available has varied over time, phasing down under the 2017 tax law and then, under recent legislation, being restored for property acquired after a stated date in 2025. Because the percentage and date rules are technical and have changed, confirm the current-year rules before you buy. Key points:

Bonus applies automatically unless you elect out by asset class.
It has no income limitation, so it can create or increase a net operating loss.
It can apply to used property if acquired from an unrelated party.
State conformity varies.

Section 179 and bonus can be combined: apply Section 179 first, then bonus to the remaining basis, then regular depreciation.

Small purchase safe harbors

Rather than depreciating every small item, the IRS provides safe harbors:

De minimis safe harbor: generally lets businesses without an applicable financial statement deduct items costing up to $2,500 per invoice or per item, if the business has a written accounting policy (in some cases) and treats the item as an expense on its books. Businesses with audited financial statements have a higher threshold. You elect it annually with a statement on your return.
Routine maintenance safe harbor and small taxpayer safe harbor for buildings, with their own conditions.

Make a written capitalization policy, such as expensing items under a set dollar amount, and apply it consistently. See chart of accounts basics.

Buying assets: planning cautions

Business need first. A purchase that saves 30 cents in tax on the dollar still costs 70 cents of real cash. Do not buy a truck to save taxes.
Placed in service. The deduction depends on the date the asset is ready and available for use in the business, not when it was ordered or paid.
Recapture on sale. Selling depreciated property at a gain generally triggers recapture as ordinary income up to the depreciation taken, and for real property, unrecaptured section 1250 gain taxed at a maximum rate of 25 percent. Accelerated deductions now mean higher recapture later.
Cash flow and financing. Financed purchases can be deducted in full even though payments are spread over years, but you must handle the debt.
Loss and QBI effects. Large deductions can reduce taxable income and the QBI deduction, and can create losses subject to limits. See tax basis basics.
Alternative minimum tax and state taxes. Rules may differ.
Owner-level limits. Loss limitations apply for S-corp and partnership owners. See S-corp shareholder basis.

Real estate and cost segregation

For buildings, depreciation is generally 27.5 years (residential rental) or 39 years (nonresidential). A cost segregation study identifies components of a building that can be depreciated over shorter periods (5, 7, or 15 years), which can accelerate deductions, especially in combination with bonus depreciation. It is an engineering-based analysis and best used for larger properties, with consideration of rental loss limits and recapture. See real estate in an LLC or personal name.

Records to keep

Invoices and proof of payment for each asset.
Date placed in service.
Description and business-use percentage.
Recovery period and method chosen.
Fixed asset register showing cost, depreciation taken, and disposal details.
Mileage logs for vehicles.
Elections made (Section 179, bonus opt-outs, safe harbors).

Common mistakes

Expensing assets that should be capitalized without a valid election or safe harbor.
Claiming 100 percent business use on mixed-use property.
Ignoring the placed in service date.
Not tracking assets after purchase, leading to missed disposal or recapture reporting.
Forgetting state differences.
Buying an asset late in the year without confirming it was placed in service.
Claiming Section 179 in excess of taxable business income without proper carryforward.
Depreciating land.
Failing to file Form 4562.

A simple annual routine

List all purchases of equipment, furniture, vehicles, and improvements for the year.
Apply your capitalization policy and safe harbor elections.
Decide on Section 179 and bonus with your tax adviser based on income projections.
Update the fixed asset register.
Reconcile to the balance sheet.
Provide the schedule to your preparer.

For help planning equipment purchases and depreciation elections, AE Tax Advisors can assist, and a discovery call is a good first step.