By Mark E. Battersby
In the not so distant past, marine fabricators spent hundreds of hours or large amounts of money hiring a programmer to customize an accounting system for their shops. Fortunately, the days of cumbersome, manual systems are long past, and today there are a number of affordable and full-featured software packages that allow business owners to track and manage every aspect of their operation’s finances. Expenses can be reduced for the accounting software and for the computers needed to operate it, along with many other business operations, under current tax laws.
Under our federal tax rules, computers and peripheral equipment are classified as “qualified technological equipment” and are usually written off or depreciated over a five-year period. The American Recovery and Reinvestment Act (ARRA) that became a reality early in 2009 increased the write-off possibilities. For example, the increased Section 179 first-year expensing allowance was extended one additional year.
Section 179 property is depreciable personal property when purchased for business use. An expense deduction allows marine fabricators who choose to treat the cost of qualifying property, such as computers, called Section 179 property, as an expense rather than as a capital expenditure. Off-the-shelf computer software placed in service last year, before 2010, is also treated as Section 179 property.
A dollar limit of $250,000 is placed on the maximum amount of Section 179 property that a marine fabricator may expense and immediately write-off during the tax year. That annual dollar limitation is reduced, dollar for dollar, by the cost of Section 179 property placed in service during the year in excess of an investment limitation of $800,000.
New—and temporary—50-percent bonus depreciation deductions were also included in ARRA for qualifying depreciable property acquired after Dec. 31, 2007, and placed in service before Jan. 1, 2010. Unlike the Section 179 expensing election, however, there is no limit on the total amount of bonus depreciation that may be claimed in any given tax year.
The bonus allowance is only available for new property (property whose original use begins with that taxpayer) that is depreciable under the Modified Accelerated Cost Recovery System (MACRS) and has a recovery period of 20 years or less. Off-the-shelf computer software depreciable over three years under Section 167(f), also qualifies for bonus depreciation.
Depreciation deductions for so-called “listed property” are subject to special rules. Computers and peripheral equipment, cellular telephones and similar telecommunications equipment are lumped into the “listed property” category along with cars, boats and airplanes and “amusement property,” because all lend themselves to personal use. Unless used more than 50-percent for business, no deduction can be claimed for listed property. In fact, unless used more than 50-percent for business, depreciation deductions on listed property must be determined under an alternative depreciation system (ADS).
Generally, the purchase of computer software can be compared to the purchase of any business asset: If computer software has an expected useful life of longer than one year, its cost should be written off or deducted over a 36-month period. Although treated as a capital asset, most off-the-shelf software can, at least for the time being, be expensed and immediately deducted as Code Section 179 property.
Depreciable off-the-shelf computer software placed in service during the 2009 tax year, is expensed and immediately written off under Code Section 179 of the Internal Revenue Code, our basic tax law. Again, this is software that is readily available for purchase by the general public, is subject to a non-exclusive license and has not been substantially modified, and which is usually depreciable over three years.
Like computers, computer software placed in service from Jan. 1, 2003, to Dec. 31, 2010, is eligible for a Section 179 deduction. This means that 100-percent of the cost of software can be deducted in the year purchased.
When software comes with a computer and its cost is not separately stated, it is treated as part of the hardware and is depreciated over five years. Under Section 179, however, the entire computer system (including bundled software) can be written-off in the first year.
In a related area, the IRS has yet to issue formal guidance on the treatment of website development costs. However, informal internal guidance suggests that one appropriate approach is to treat those costs like an item of software and depreciate them over three years.
It is clear that taxpayers who pay large amounts to develop sophisticated sites have been allocating their costs to items such as software development (currently deductible, like research and development costs), utilizing the Section 179 first-year expensing election and even as currently deductible advertising expenses.
Unfortunately, as with many areas of our tax law, there’s far more to computers, peripherals and software deductions than a simple depreciation write off. Fortunately, the benefits far outweigh the restrictions and limitations for those willing to adhere to the rules—and seek professional assistance whenever necessary.