Although it's known as a dental practice, you are really running a business. To create a thriving practice with a growing base of recurring patients, you have to make some hard decisions about investing in equipment and other financial allocations.
Fortunately, a great number of experienced professionals have gone down this road and prepared a path for you. The federal tax code's Section 179 deduction was specifically designed to help dentists get the equipment they need right away and to get a big break on their year-end taxes. This incentive was created by federal lawmakers to encourage small businesses like yours to invest in yourself. Here's how it works.
What Is the Section 179 Deduction?
This tax break applies to both purchased and leased equipment, although you may see a bigger immediate impact to your business by using a leasing structure. In brief, Section 179 allows a dental practice to deduct the full purchase price, up to $500,000, of qualified dental equipment from gross income. This only applies to equipment put into service during the tax year. Ordinarily, dentists would just take depreciation deductions over several years for their new equipment.
What Is a Depreciation Deduction?
The IRS specifies that depreciation deductions apply to most types of tangible property, including buildings (but not the real estate itself), machinery, cars, office furniture, standard dental equipment, office chairs, lighting for the waiting room, updated X-ray machines, sterilizers and computers. Most of the medical equipment you use for your business is covered. In some cases, you can even depreciate the value of some types of intangibles that are essential for operations, such as your business software, patents, copyrights and some intellectual property.
Most business owners depreciate these in portions over several years. For example, if the equipment is likely to have an active life of seven years, you would normally deduct one-seventh of the total cost each year. Section 179 turns that around. It allows you to take a deduction for the full purchase price of the equipment in the year that it went into service, even if the equipment was leased.
You could end up with lower taxes plus a profit on the transaction, which could result in more business to help you pay off the lease early. However, be aware that you can only claim Section 179 for equipment secured by non-tax capital leases, not operating leases.
What's the Difference Between a Capital vs. Operational Lease?
The big difference is that a capital lease represents a form of ownership of the equipment, and it must be treated as an asset on your balance sheet. An operating lease is more of a short-term rental agreement and is handled as merely an operating expense. Operational leases, aka service leases, are generally used for high-tech equipment that must be upgraded frequently. For example, professional copy machines are often managed as operational leases.
The four essential elements of a capital lease are:
- The title is automatically transferred to you at the end of the lease.
- You must have the option to purchase the equipment outright for substantially less than the fair market value.
- Your lease term covers three-quarters of the equipment's useful life.
- The total present value of the lease payments must exceed 90 percent of the equipment's fair market value.
To write down the value of equipment using Section 179, it must be secured through a capital lease agreement or purchased.
Reasons for Buying vs. Leasing
Section 179 applies to both, so that isn't the deciding factor, but there are at least four good reasons to consider buying over leasing:
- Purchase normally comes with an option for a full warranty in case something goes wrong over the life of the equipment.
- Once you own the equipment, you have a tangible asset that you could sell at some point.
- As long as the equipment is in good working order, you can use it as collateral to obtain additional financing.
- You don't have to worry about reading and evaluating all the fine print on a complex leasing contract.
On the other hand, leasing is a better option for obtaining the latest equipment without a huge cash outlay. If an outright purchase will put your dental practice in a cash crunch, leasing can be a better choice.
How to Decide Which Is Right for Your Practice
Should you invest in new equipment or wait? Purchase or lease? Take Section 179 or depreciate? There's no definitive answer because your financial situation is complex and individual. However, there are clear advantages over taking a standard deduction according to normal depreciation.
To review, if you purchased or leased (with a capital lease) equipment this year, you have an option for reducing your gross income. You can apply Section 179 of the tax code and deduct the full purchase price, not just a partial depreciation, of that equipment up to $500,000.
The key understanding you should take from this discussion is that you should involve your CPA in strategic planning for the future of your business, not just investigating the best tax breaks based on your financial decisions from the past. Together you can plan immediate actions in order to take advantage of financial and tax incentives like Section 179. Contact the CPAs at Goldin Peiser and Peiser for additional information on tax incentives for your dental practice.