The timing of purchases is critical for tax benefits.
by Rick Willeford, MBA, CPA, CFP
The best time to buy equipment is any time that the investment will produce enough new revenue to justify it! That being said, there are some fine points to consider relative to taxes, credits, and cash flow. As I will explain, 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.
Tip: 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, the IRS requires you to depreciate the cost over a secified life span. This is typically seven years for traditional equipment and furniture, and five years for computers and other electronic devices. Trap: Anything with a life expectancy of more than 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 multinational company! We will discuss the implications of this.Tip: As dental units get more sophisticated, the distinction between traditional seven-year equipment and five-year computers gets blurred; you and your CPA can decide how aggressive you want to be with such items.The IRS generally allows 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 one-eighth of a year's depreciation if more than 40 percent of your total purchases are made in the last quarter of the year.
There is, however, an important exception to the general depreciation rules. You can elect to treat a certain amount of new equipment you place in service as though it were 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 2001 and 2002 is $24,000 and $25,000 thereafter. (The business community had hoped the recent tax law would increase this limit, but it was not to be.) You certainly want to time your purchases to take maximum advantage of this election. 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 — in the year the equipment is purchased and placed in service.
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, for example, year three, and determines that some of your supplies (can you say "handpieces"?) were actually equipment, it is then too late to make the election. That had to be made in year one!
Tip: If your "small" purchases are under the $24,000 limit, you can protect yourself by treating them as equipment and making the expense election. The tax result is the same as if they were supplies, except that 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 cannot take this deduction on the furnishings or appliances, because you are furnishing "lodging."
Trap: If you personally buy equipment and lease it to your professional corporation (PC), you are not in a trade or business. Therefore, you cannot take the first- year deduction.Third, this election is only allowed fully if your total equipment purchases for the year are less than $200,000.
Tip: Split your purchases that are over $200,000 into two years, if the election is important to you. Likewise, split a smaller purchase in order to have $24,000 in each year.Fourth, the stricter limits on car depreciation make it impractical to use this deduction on cars.
Fifth, the $24,000 limit applies to your entire tax return — not just each business. You and your spouse may have separate businesses; yet, you both are limited to a total $24,000 deduction. A similar problem arises if you are a member of several partnerships or S corporations that "pass through" your share of the deduction.
Trap: Anything over $24,000 in total is wasted forever, so be careful to coordinate with your other partners/shareholders or CPA for the second business.Sixth, you can specify which items are to be expensed.
Tip: If you buy a combination of seven-year and five-year items, elect to expense the seven-year items first, since that reduces the longer-depreciation items.Seventh, there may be rare cases when 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.
Eighth, it goes without saying that you must purchase the equipment to take this election. Leasing does not count.
Tip: Maximize handicapped access credits and deductions. You may take a $5,000 tax credit (50 percent of the cost over $250, up to $10,000) for "eligible access expenditures" to comply with the Americans with Disabilities Act (ADA). The law itself gives very little specific guidance, so the use of this credit has varied widely. Over time, the IRS has disallowed the credit for digital X-ray systems, stating that the resulting radiographs are primarily for the doctor and not for the patients. The IRS also has disallowed the credit for panoramic 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, CPAs and other tax advisors were hopeful that at least the intraoral camera would pass muster, but see the discussion below. If you truly have a qualifying expenditure, the "placed in service" timing still applies. Trap: You cannot 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.Tip: Removal of architectural barriers from offices built before Nov. 5, 1990, 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 improve access substantially 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 rehabilitation project on a pre-Nov. 5, 1990, 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 seven 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:
- specialized plumbing for nitrous oxide, dental units, and laboratories
- data/communications wiring
- carpet and wall coverings
However, you must get a specific breakdown from your builder.
Tax Court Shutters Intraoral Cameras
In a July 24, 2001 decision (117 T.C. No. 3), the tax court disallowed the ADA credit for a California dentist's intraoral camera. The court substantially — and perhaps unfairly — raised the standard for taking the credit. The credit is not allowable for expenditures merely to improve handicapped access in compliance with the ADA. Instead, the expenditure must be made to bring the user into compliance with the ADA in the first place. Since the dentist was already using handwritten notes to communicate with hearing-impaired patients and was already treating them, he was already in compliance with the ADA!
Specifically, "The system is not a replacement for, or acceptable alternative to, handwritten notes for purposes of the Section 44 credit. The system was not designed or marketed as a communication device for hearing-impaired patients, and its use was not limited to hearing-impaired patients. The system might allow a patient to understand the recommended treatment better, but it does not eliminate the need for the dentist and the patient to communicate with each other. As a result, the system does not constitute an effective method of making aurally delivered materials available to hearing-impaired individuals."
Although the Tax Court is at the bottom of the food chain in the judicial system, and its decision seems overly restrictive, it's all we have for now. It may take a trip to court if you want to defend your taking the credit. By the way, the total amount of tax at stake was only $3,225, yet the IRS was willing to go to court.
