Say you need to buy a machine or other equipment in 2009 but it hasn’t been a good year for you. Profits are off and all you see is red ink, but you still need the machine and the seller is willing to give you attractive financing. Because you aren’t profitable, you can’t benefit from an election to expense (deduct) the cost of the equipment this year (called the Sec. 179 deduction). The result: You have to depreciate its cost over a number of years (the recovery period, five or seven years for most equipment, is fixed by the tax law). However, there is some leeway in depreciation rules for 2009.
You automatically qualify for 50% bonus depreciation for federal income tax purposes, which lets you deduct half of the cost upfront, plus any regular depreciation allowance you’re entitled to. For example, if the equipment cost $20,000 and has a five-year recovery period, you can deduct $12,000 this year ($10,000 using 50% bonus depreciation, plus $2,000, the regular depreciation allowance on the other half of the cost).
You can opt not to take bonus depreciation. This might be a good step if you’re just starting out and you expect to be more profitable in the future when the write-off would be worth more to you. Continuing the example above, your 2009 depreciation allowance would be $4,000; $16,000 would be depreciated over the remaining years in the recovery period.
On the other hand, claiming as much depreciation as possible this year, even if you are in a loss situation, can be a good thing taxwise. It adds to your net operating loss; this loss can be carried back to offset income in prior years (usually two years, but five years in some situations) and give you an immediate refund of taxes from those prior years.
In deciding how to depreciate property, keep in mind that your state income tax rules may not follow the federal rules. Many states have not conformed their income tax rules with federal law. You can find a listing of the treatment of bonus depreciation at the state level from BNA Sofware.
Bottom line: Work with your tax advisor before you buy equipment. In some cases, it may make more sense to lease it rather than buy it.