Tax Aspects When Buying Equipment

R. F. Willeford, MBA, CPA/CFP

      The best time to buy equipment is any time that the investment in the equipment will produce enough new revenue to justify it! That being said, there are in fact some fine points to consider relative to taxes, credits and cash flow. As explained below, you should make plans to purchase your equipment well before the end of the year so you can be sure it is “in service” by year end.

Maximize depreciation and first-year deduction. As you may be aware, when you purchase major items of furniture or equipment for a trade or business and place them in service, you are required to depreciate the cost over a life specified by the IRS. This is typically five years for traditional equipment, computers and other electronic devices and seven years for furniture. 

W Trap  Anything with a life expectancy over one year is “equipment” as far as the IRS is concerned. As a practical matter, many people consider small expenditures under a few hundred dollars as “dental supplies”, but be aware that is technically incorrect. The IRS recently disallowed deductions as small as $600 in the audit of a huge multi-national company! The implications of this are discussed below.

R Tip:    For health care providers, under Rev Proc 87-56, Class Life 57 is available to allow a 5-year depreciation period for dental equipment vs. the normal 7-year period!

      You are generally allowed one-half year’s depreciation regardless of when you actually buy the equipment during the year. However, there is an exception that states that you only get 1/8 of a year’s depreciation if more than 40% of your total purchases are made in the last quarter of the year. 

      There is an important exception to the general depreciation rules. You can elect to treat a certain amount of new or used equipment you place in service as though it was dental supplies and get an immediate expense deduction in the year of purchase. You have probably heard your CPA refer to this as the “Section 179 deduction”. The allowable limit in 2004 and 2005 is $100,000 and $25,000 thereafter. So you certainly want to time your purchases to take maximum advantage of these elections. However, there are several issues to keep in mind.  

      First, this is an “election” you must make in the first year the equipment is purchased and placed in service–it is not automatic. The “election” is the easy part and is normally part of your tax return. The key is the timing. You can only make the election (or claim regular depreciation) the year in which the equipment is purchased and placed in service.

W Trap: It is not sufficient to give the equipment supplier a check on December 31–the equipment must be in service by December 31 (or your fiscal year end)!

      If the IRS audits you in, say, year three and determines that some of your supplies (can you say “dental handpieces”!) were actually equipment, it is too late to make the election. That had to be made in year one!

R Tip:    If your “small” purchases are under the Section 179 limit, you could protect yourself by treating them as equipment and making the expense election The tax result is the same as if they were supplies. (That’s not quite true: you have to consider possible property tax on these “equipment” items.)

      Second, the election is only allowed for items used in a “trade or business”. (As an aside, if you own rental real estate with leases primarily over 30 days, you can not take this deduction on the furnishings or appliances because you are furnishing “lodging”.)

W Trap: If you personally buy equipment and lease it to your PC, you are not in a trade or business, so you can not take the first year deduction.

      Third, the 179 election is only allowed fully if your total equipment purchases for the year are less than $400,000, as adjusted annually by the IRS.

R Tip:    Split purchases over $400,000 into two years, if the election is important to you. Likewise, split a purchase in order to have $100,000 in each year.

      Fourth, the stricter limits on car depreciation make it impractical to use this deduction on cars except for the largest SUVs and trucks over 6,000 pounds. (After 10/22/04, the first-year deduction for SUVs is back to the old $25,000.)

      Fifth, the 179 limit applies to your entire tax return–not just each business. You and your spouse may have separate businesses, but you are limited to a total $100,000 deduction between you. A similar problem arises if you are a member of several partnerships or S corporations that “pass through” your share of the deduction.

W Trap: Anything over $100,000 in total is wasted forever, so be careful to coordinate with your other partners/shareholders or CPA for second business.

      Sixth, you can specify which items are to be expensed.

R Tip:    If you buy a combination of 7-year and 5-year items, elect to expense the 7-year items first, since that reduces the longer depreciation items.

      Seventh, there may be rare cases you do not want to take the deduction. For instance, if you open a new office late in the year and have very little income from the practice and other sources, you don’t want to waste the deduction while in a very low tax bracket. A large deduction inside a corporation may not be immediately useful either.

      Eighth, it goes without saying that you must be purchasing the equipment to take this election. Leasing does not count.

Maximize handicapped access credits/deductions. You may take a $5,000 tax credit (50% of the cost over $250, up to $10,000) for “eligible access expenditures” to comply with the Americans with Disabilities Act (“ADA Credit”). The law itself gives very little specific guidance, so use of this credit has varied widely. Over time, the IRS has disallowed the credit for digital x-ray systems, stating that the resulting x-rays are primarily for the doctor and not for the patient. The IRS has also disallowed the credit for panorex machines without fixed seating and for dental chairs with arms that raise, stating that their principal purpose was not to provide handicapped access. Until now, the tax community was hopeful that at least the intra-oral camera would pass muster, but see the discussion below. If you truly have a qualifying expenditure, the “placed in service” timing above still applies.

W Trap: You can not take the credit if you had gross collections over $1,000,000 in the prior year OR if you have over 30 full-time employees in the current year.

R Tip:    Removal of architectural barriers from offices built before 11/5/90 also qualify for this ADA credit

      In addition to the ADA credit, IRS Code §190 allows you to immediately expense (vs. depreciate over 40 years) up to $15,000 for removing architectural barriers in any existing office (but not new construction) to substantially improve access for the handicapped or the elderly. (This includes widening doorways and hallways, upgrading a bathroom, adding an access ramp, etc.). Part of the cost of a rehab project on a pre-11/5/90 building could be used for the ADA credit while the rest could qualify for this deduction.  

      Some building construction costs may be depreciable as “equipment” over 7 years vs. the traditional 40-year depreciation period for the structural components of buildings. Costs that are primarily related to providing specialized services (i.e., medical/dental) vs. general building services could qualify. Such items could include a) specialized plumbing for nitrous, dental units and laboratories, b) data/communications wiring, and c) carpet and wall coverings. However, you must get a specific breakdown from your builder.   Even better, have a Cost Segregation Study done by an independent engineer, because the IRS is looking for an excuse to challenge your own figures -- or those from your builder.