Every year, you buy items such as computers and office equipment to be used in your business. If these assets remain useful beyond the year that you bought them, you generally cannot deduct the entire cost as an expense in that first year's tax return.

But there are exceptions. Just because the Internal Revenue Service (IRS) claims that your computer has a five-year life, that doesn't mean you have to deduct the cost of that computer over five years. If it's important for you to maximize your deductions in the year that you bought the asset, you can take advantage of some special elections that allow you to deduct the cost sooner.

Assets you must depreciate

First, let's make it clear what assets we are referring to. Here are the requirements for assets that fall under the IRS depreciation rules:

• Must be assets you own   For a leased asset, you expense the lease payments as you pay them instead of claiming depreciation.
• Must be used in your business   That said, an asset doesn't have to be used 100% for business. If you use your computer mainly for business, but you play computer games on it 25% of the time, you can deduct 75% of the computer cost by using this rule. Note, however, that inventory is not a depreciable asset.
• Must be useful in your business beyond the year that you bought it   Generally, you depreciate an asset if it has a useful life of longer than one year. Obviously, you can't depreciate office supplies.
• Must be something that wears out, decays, or gets used up   In other words, this asset definitely has an end to its life. This means that land cannot be depreciated.

Section 179 expense

Many business owners take advantage of a special election called Section 179. You may use this election to deduct 100% of the cost of your depreciable asset in the year that you buy it. The election must be made in the first year that you use the asset in your business.

For instance, you can claim this deduction for off-the-shelf computer software that you begin using in your business before 2006 (2005 is the last tax year that this deduction is allowed).

Note, however, that the Section 179 election can be used only for personal property. (Land and land improvements, such as buildings, are real property, not personal property.) Furthermore, you cannot claim a Section 179 deduction for property used to produce rental income or for property used less than 50% for business.

Also, there are times when a Section 179 deduction is limited to less than 100% of the asset cost. These are some examples:

Dollar limits

• The maximum cost that you can elect to deduct in 2004 is $102,000, whether you are claiming this deduction for one asset or several assets. (If you are not preparing a tax return for the year 2004, you should find out the maximum amount for that tax year.)
• If the cost of all assets that you bought in one year is more than an IRS-defined amount, the maximum deduction that you can claim is reduced. For example, the $102,000 maximum for 2004 is reduced by one dollar for every dollar over $410,000 that you spent on assets.
• If your business is included on your individual tax return and you are married, this limit is shared between you and your spouse.

 Note   This article does not cover special rules for passenger automobiles.

Business income limits

Calculate your total income and losses from your business during the year. Subtract all expenses other than the Section 179 expense. If you already have a loss, you cannot take advantage of this election for this year.

However, if your business is taxed as part of your individual return, you can add all income and losses from trades or businesses for the year. In other words, if you have a salary from a separate job, you can add this salary to your business income when you calculate this limit.

If you meet the Section 179 election requirements, but you are not allowed to deduct the entire cost in the first year because of your business income limits, you can either:

• Elect to claim the limited amount that you can deduct in the current year and deduct the rest of the asset's cost as depreciation over the IRS-defined useful life.
• Elect to claim the entire cost. Take advantage of the deduction allowed in the first year and carry over the remaining Section 179 expense to the following year. If your business income is increasing, this helps speed up your deductions.

Possible time limit

Note that the Section 179 expense election was scheduled to be unavailable after the 2005 tax year. However, the American Jobs Creation Act of 2004 extended the election through 2007. There is always the possibility that the election will be extended again later.

Special first-year depreciation allowance

You also are allowed to claim a special depreciation allowance for certain assets that must be depreciated. You may use this allowance to deduct 50% of the cost of the assets. It can be used for any cost that was not claimed as a Section 179 expense and can be claimed only in the year that the asset is placed in service in your business.

In general, this allowance can be claimed for new property that the IRS defines as a useful life of 20 years or less.

There are several reasons that you might claim this allowance instead of claiming the Section 179 election:

• You have already claimed the maximum Section 179 deduction.
• You would like to claim more than the normal depreciation deduction this year, but you still want some depreciation deduction to offset your business income in future years.
• You probably won't keep the asset for its IRS-defined useful life, and you want to minimize your tax liability at the time of sale.

Sales of assets you are depreciating

If there is a chance that you will sell the business asset before the end of its useful life, you might not want to elect the Section 179 expense or deduct the special first-year depreciation allowance.

Normally, the sale of business assets falls under the special rules for capital gains. The tax rate on the gain from these sales might be lower than the tax rate on your other ordinary income. If you claimed one of these special deduction allowances on an asset and then sell it, the IRS requires that you 'recapture' any amount you deducted that was more than the amount that would have been deducted by using regular depreciation rules. The amount that gets recaptured is taxed as ordinary income.

Obviously, you won't always know whether you'll keep the asset for its entire life. The risk of reporting this gain as ordinary income in the future can be offset by a significantly reduced payment to the IRS this year.

Deduct your business assets now

If your business is like most businesses, you are always looking for ways to increase the deductions on your tax return. Depreciation rules clearly state that certain assets you bought for your business cannot be expensed right away. However, you can take advantage of a couple of large special allowances that might help you speed their deduction. Both of these special deductions are allowed only in the year that you start using the asset in your business.

If elected, the Section 179 expense deduction might allow you to deduct 100% of the cost of the assets. It can make a significant difference in the tax you pay on this year's tax return, but it could also put you at risk for higher tax in future years when you are still paying off the asset.

If you do not claim a Section 179 expense, or if this deduction is limited, you can still deduct the special 50% depreciation allowance for new property other than real property, such as buildings. This allowance accelerates the deduction over normal depreciation while still leaving some depreciation expense for future years.

If you claim these allowances and sell the asset before the end of its useful life, you will be taxed on the extra amount you claimed. However, the smaller payment to the IRS in that first year might be significant enough to your business that you're willing to risk paying some of it back later.