In a volatile economic environment where every dollar counts, your medical practice’s leadership needs to know the distinction between traditional tax deductions and depreciation-related tax breaks. For instance, a medical practice can take an immediate deduction for various types of expenses that can be defined as ordinary and necessary business expenses. These include hand sanitizer, face masks, gloves and stationery. In addition, rent, utilities, advertising, insurance (but not health insurance), maintenance and repair costs are generally considered part of normal operations. Therefore, they may be deductible in full right away.
However, expenses that benefit more than one year may have to be capitalized and written off over several years. Generally, depreciation involves capital assets — including buildings, computers, X-ray equipment, office furniture and, sometimes, vehicles. These items lose their value over time and, therefore, usually offer only gradual, incremental tax breaks under the specific tax rules for depreciation. But two longstanding depreciation-related tax breaks — the Section 179 deduction and bonus depreciation — may offer an exciting tax-saving opportunity.
What is Sec. 179? When delving into the details of depreciation, it’s critical to understand Sec. 179 of the Internal Revenue Code. Why? Because Sec. 179 “allows taxpayers to deduct the cost of certain property as an expense when the property is placed in service.” In other words, a medical practice can immediately apply an expense deduction for purchases of depreciable business equipment, instead of capitalizing the purchases and depreciating them over time. Bear in mind that the “placed in service” stipulation in Sec. 179 is significant. You can’t use the deduction for equipment you’re storing for later use. The equipment must be in use for the Sec. 179 deduction to be valid.
For 2022, the maximum deduction was $1.08 million. This deduction limit is reduced dollar for dollar for qualifying property placed in service in excess of $2.7 million. The IRS notes that the Sec. 179 deduction applies to tangible personal property, such as machinery and equipment, as well as to qualified real property. This includes qualified improvement property and some improvements to nonresidential real property, such as HVAC, fire protection and alarm systems.
Depreciation allows for systematic write-offs over the estimated useful life of an asset. This is typically defined as five to 10 years, but specific equipment sometimes has a longer or shorter useful life. For example, computers and medical equipment are classified as having a useful life of five years, while office furniture generally is assumed to have a useful life of seven years.
How does it work? Let’s assume you need to buy medical equipment that you’ll use exclusively for your medical practice. The equipment costs $50,000 and has no salvage value, meaning you can’t resell it at the end of five years. Under normal depreciation rules, you would have to depreciate the equipment over five years at $10,000 annually. Sec. 179 allows your practice to deduct the entire $50,000 in the current year. In a 32% tax bracket, your tax savings could reach $17,500. Thus, the cost of the equipment after the tax savings is $32,500.
What is bonus depreciation? Another term often seen in discussions of equipment depreciation deductions is bonus depreciation. This is a tax incentive allowing a company to immediately deduct a significant percentage of the purchase price of eligible assets instead of writing them off over the useful life of the asset. Sometimes it’s also called the “additional first-year depreciation deduction.”
There are two key elements to bonus depreciation:
- A significant percentage of the amount spent on eligible purchases can be deducted the year they were purchased, instead of spreading the depreciation over several years, and
- Last year (2022), bonus depreciation allowed for 100% upfront deductibility of depreciation, which results in 20% depreciation in each following year until its final year in 2026.
The Tax Cuts and Jobs Act made significant changes to bonus depreciation, such as increasing the bonus depreciation percentage from 50% to 100% for qualified property acquired and placed in service after September 27, 2017, and before January 1, 2023. But those changes are scheduled to decline by 20% each year until 2027, when they will expire. Consult with your accountant for more information about bonus depreciation and how it may work along with Sec. 179.
How can you get started? Planning is key to taking advantage of depreciation-related tax breaks. Medical equipment may break down and require replacement immediately. But many assets — such as office furniture or even an X-ray machine — need regular replacement.
And the potential benefit of planning is considerable: By decreasing your tax burden, you can reduce expenses related to taxes and thereby boost cash flow. Tax laws, however, are complicated and constantly changing. Discuss asset acquisitions and whether they’ll qualify for Sec. 179 or bonus depreciation with your CPA — preferably before you buy.