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Make Tax Rules Work to Your Advantage

You need to understand how the acquisition of fixed assets is treated under tax law, and specifically, how Internal Revenue Code Section 179 and the rules for bonus depreciation work.
Art Wiederman, CPA
PUBLISHED: Thursday, January 19, 2017
The largest expenditures you will make over your dental career will be the acquisition of fixed assets. Whether you have expanded or are planning to expand your practice, are undertaking a new build, or are purchasing an existing practice, you will spend hundreds of thousands of dollars on equipment, furnishings and leasehold improvements.
 
One of the most frequent questions dental-specific CPAs are asked is, “We just spent thousands of dollars on new equipment. Can we write off the purchase this year, and how much in taxes will we save?”
 
The answer is complex. You need to understand how the acquisition of fixed assets is treated under tax law, and specifically, how Internal Revenue Code Section 179 and the rules for bonus depreciation work. Most important, you need to know how to use them to your advantage.
 
SECTION 179
 
Under federal income tax law, the purchase of fixed assets is subject to depreciation. Dental equipment and computer equipment is depreciated over five years, furniture and fixtures over seven years, qualified leasehold improvements over 15 years, and structural components over 39 years. 
Internal Revenue Code Section 179 allows you to forego depreciating qualifying property over the time periods noted above and allows you to expense these purchases in the current year subject to limits set by Congress.
 
The PATH Act set the limit for taking deductions for purchase of fixed assets at $500,000 per year and has provided for indexing this amount for inflation. For virtually all of our dental clients, whether single owners or group practices, this limit was more than enough to take care of their annual fixed asset expenditures.
 
WHAT QUALIFIES FOR SECTION 179
 
Section 179 property is defined as tangible personal property used in a trade or business that is placed in service during the year.
 
In a dental practice, this includes dental equipment, computers, furniture and fixtures along with carpeting (there are special rules for carpeting depending on whether it is tacked or glued down) and most dental cabinetry (most dental cabinetry is modular and can be removed and taken elsewhere). In addition, there is a category of assets called qualified leasehold improvements, which also qualify for Section 179. This category involves any improvement to a building’s interior (usually moving and building walls). The building must be nonresidential real estate pursuant to a lease that is occupied by the dentist and the improvement must be placed in service more than three years after the building has been first placed in service. If the dentist owns the building and leases it to his or her own corporation, the improvements do not qualify for Section 179. However, they should qualify as qualified improvement property and will qualify for 50 percent bonus depreciation.
 
Any assets that are considered structural components of a building, such as the building shell, plumbing and electrical work, will not qualify. Also, if you purchase a vehicle that is under 6,000 pounds, it qualifies, but you are limited to the annual luxury depreciation limits, which are very low. For vehicles that exceed 6,000 pounds, the Section 179 deduction is allowed, however it is limited to $25,000.
 
Also, you must remember that the asset must be placed in service in the year that you wish to take the deduction. So, for example, say purchased digital X-ray equipment for four operatories for $50,000. Whether you pay for the equipment before the end of the year in full or make a deposit, if the equipment is not installed and in a “state of readiness” then – whether you wrote the check on Dec. 31 or made a deposit – you do not get the deduction. 
 
On the other hand, if you have the equipment installed on Dec. 28, and you do not pay for it until January of the next year, you can take the Section 179 deduction. 
 
DOES YOUR BUSINES ENTITY TYPE AFFECT DEDUCTION ELIDGIBILITY? 
 
Yes it does. You and your tax adviser must note the following:
  • For sole proprietors, C-corporations, single member limited liability companies (which are generally taxed like sole proprietorships), and partnerships where the individual doctors or their wholly owned professional corporations are the partners, the rules are liberal. For sole proprietors and single member limited liability corporations (LLCs), as long as you are “at risk” in the investment, which means you either paid cash or took out a bank loan for which you are personally liable, then you get the Section 179 deduction. 
  • For general partnerships or LLCs with more than one member, the rules are the same except you have to make sure you have basis in your partnership interest. As a general rule, as a partner, you receive partnership basis for any debt you incur for which you are personally responsible. So, if you borrow $250,000 to purchase dental equipment and you take out a $250,000 loan, you will receive basis in your partnership interest sufficient to take the Section 179 deduction.
  • For S-corporations, there is a huge trap for doctors who take out bank financing to purchase fixed assets and who want to take the Section 179 deduction. Say you decide to purchase a cone beam machine in your practice in 2017.  The cost of the machine is $175,000 and you want to write the entire amount off in 2017 because your practice is doing much better than it did in 2016. So, you go to the bank and take out a loan through your S-corporation for $175,000 and you are personally liable for the loan. No problem-right? Unfortunately, not right. There is a concept in tax law called S Corporation basis. It is similar to basis in partnerships and LLCs. As noted above in a partnership or LLC, if you are personally liable (at risk) for the loan, you get the deduction. However, under the S-corporation rules, even though you are personally liable for the loan, you do not get S-corporation basis and you do not get the Section 179 deduction. If you pay off the loan over five years, by paying the principal of the loan, profit is created in your S-corporation which creates basis. How can you get the deduction in the S-corporation? The only ways would be:
  • A) You contributed the money personally (by a loan, or preferably a capital contribution) and are paying for the machine yourself or
  • B) You are using bank financing, you borrow the money personally from the bank, then contribute the $175,000 in bank proceeds to the corporation. A capital contribution or loan by you to the S-corporation creates S-corporation basis and allows you to take the deduction.
Complicated enough? If you are purchasing any appreciable amount of fixed assets for your dental practice, it is critical that you review the transaction with your certified public accountant prior to completing it. Unfortunately, I have received phone calls in March or April, when a dentist is completing his or her taxes, during which the dentist has said to me, “I was told that if I bought this equipment before the end of the year I could write it off. Now my CPA tells me I can’t and I owe a ton of taxes.”  At that point, my compassionate side kicks in, but beyond that, there is little I can do.
 
Art Wiederman is a CPA and managing partner of Wiederman and Chamberlain, a CPA firm that works with more than 200 dentists in Tustin, California. He is a frequent lecturer at local, state and national dental meetings and is a founding member of the Academy of Dental CPAs (ADCPA), which comprises 26 dental CPA firms across the country, servicing more than 8,000 dentists. 


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