As a professional that deals, a lot, with expensive software, when it comes around to tax time, the dilemma is whether to deduct the entire cost of the software as an expense or to depreciate the cost over time. Sometimes, deducting the whole thing as an expense (or expensing it) works out better than depreciating it, and sometimes, the reverse is the case. Let us explore:
When it pays to Depreciate:
- Depreciating an asset, like a large software purchase, or ay software used to generate income for your profession or business, can generate tax savings over time. If you project or forecast generating revenues over time, depreciating that asset is beneficial, because it creates expense, over the life of the asset, that can be used to offset the revenue generated. For example if the asset life of the purchase is 5 years, every year, for 5 years, a portion of the cost can be deducted as an expense, against the revenues generated. Once you expense a purchase, that is it – you cannot come back next year to claim it again.
When it pays to expense a purchase
- The IRS has made a provision that allows for the expensing of a purchase in the year that it is bought. Ts is called a section 179 deduction. It simply means that instead of dividing the cost of the purchase over the life of the item bought, you are taking it at once. When can this be beneficial? If you are in a situation, where you or your business has a high taxable income and you need every single deduction you need, it may be beneficial to ust expense everything at once – keeping in mind that next year, that expense will NOT be available to you.
Of course, there are times when you will have a high taxable income, but based on your income and tax bracket projections for the upcoming years, you might have to just depreciate, instead of expense the item. Which scenario works best for you, will be determined between you and your accountant or the tax professional you are working with.
In the meantime, regardless of the option you end up choosing, make sure you have tangible and adequate financial records related to your purchases – receipts if possible.
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