Section 179 and bonus depreciation when you lease instead of buy

A salesperson telling you the equipment is "fully deductible this year" is telling you something that might be true, might be half true, and depends on a document you have not read yet. The deduction follows the tax owner. Work out who that is first.

Who is the tax owner

The IRS applies substance over form; the label on the cover page does not decide it. Its lease-characterisation guidance, of which Revenue Procedure 2001-28 is the usual reference point, and the depreciation rules in Publication 946 are where the tests are set out.

What section 179 actually does

Section 179 lets a business elect to expense the cost of qualifying property in the year it is placed in service, instead of depreciating it over years. Several conditions travel with it, and they matter more than the headline:

Bonus depreciation is a separate lever

Bonus depreciation under section 168(k) is a first-year percentage of the cost of qualifying property, applied after any section 179 election and before regular depreciation. The percentage has been on a legislated path and has changed more than once. State conformity is its own problem: several states do not follow federal bonus depreciation, and some do not follow federal section 179 limits either, so a deduction that works on your federal return may need adding back on your state one.

Anyone quoting you a fixed percentage for bonus depreciation without a date attached is quoting you history. Check the current position.

Where financing actually interacts with the deduction

Here is the part that gets oversold: financing does not create the deduction. If you are the tax owner of qualifying property placed in service in the year, the deduction is available whether you paid cash, borrowed, or signed a $1-out lease. Financing changes your cash flow, not your eligibility.

What financing does change is the shape of the cash. If you expense the full cost in year one but pay for the machine over 60 months, you have taken the deduction well before you have spent the money. That is a genuine timing benefit and it is the honest version of the pitch. It is not "the government pays for your machine".

The mirror image also holds. On a true lease, you have no depreciation and no section 179 election, but you deduct every rent payment. Across the whole term the total deduction is not necessarily smaller — it is spread differently. For a business with steady income and no need to accelerate deductions, that can be the better answer.

The December problem

Equipment sales spike in the fourth quarter because of section 179, and some of that buying is a mistake. A deduction is a reduction in taxable income, not a rebate. Spending $100,000 you did not need to spend, to reduce tax by some fraction of that, leaves you with less cash and a machine you did not want.

Buy equipment because the equipment earns its keep. Let the tax treatment decide the structure and the timing, not the decision.

What to do

1. Ask the funder, in writing, whether the structure is intended to be a true lease or a conditional sale.
2. Send the document to your CPA before signing, not with the return in March.
3. Confirm the current section 179 limit, phase-out threshold and bonus depreciation percentage from irs.gov for the tax year in question.
4. Ask your CPA about state conformity.
5. Check the placed-in-service date against your delivery and commissioning schedule.

What the timing benefit is worth, roughly

Illustrative only — a $120,000 machine financed over 60 months at a nominal 9%, giving a payment of $2,491.00. Suppose your combined marginal rate is 30%; use your own figure, from your own return.

In year one you pay $29,892.03 and, if the full cost is expensed, reduce tax by $36,000. Net, you are $6,107.97 ahead on cash in the first year while operating a $120,000 machine from day one.

That is the real benefit, and it is worth having. Note what it is not. Over the full term you pay $149,460.16 for a $120,000 asset, so $29,460.16 of finance cost has bought a $6,108 first-year cash advantage plus the use of the machine five years earlier than cash would have allowed. Whether that trade is good depends entirely on what the machine earns, which is the part the sales conversation skips.

The recapture case

Expensing assumes the business use holds up. If qualifying business use falls to 50% or below in a later year, the excess deduction is generally recaptured as income in that year. Vehicles and equipment that can also be used personally are where this bites.

Keep the usage records from the first month rather than reconstructing them under examination three years later.