One of the tax changes made for 2005 is the demise of the bonus depreciation option. Instead, as a small business owner, you can increase your depreciation rate by as much as 50% of cost on top of the depreciation you could otherwise take in the first year of use. This rule covers new properties such as equipment bought and put in service in 2004, computer software and leasehold improvements.

According to the publishers of the must-have tax time book series J.K. Lasser’s Guides, this new rule can affect you as a small business owner in three ways:

First off, don’t despair about 2005. There is an even faster write-off than “bonus depreciation”, and it isn’t changing. That’s like, “Yes Virginia, there is a Santa Claus.” Tax planners call it “first-year expensing” and the IRS calls it the “Section 179 deduction.” Whatever you call it, you get to write off not 50% but 100%, of the cost of the equipment in the first year of use. To the extent that you qualify for this, you can forget about bonus depreciation.

First-year expensing only works for small business. If you buy qualifying property (tangible personal property like machinery, computers, office equipment and vehicles, maybe Trojan horses) with a cost of less than $410,000, you can elect to immediately write-off up to $102,000 of the cost. The excess cost is subject to depreciation over time (including bonus depreciation for 2004). If you buy from $410,000 to $512,000 of qualifying equipment, first-year expensing is phased down — to zero at $512,000.

A crucial point: Don’t assume that you should always write off purchases as fast as possible. For example, a new business generating start-up losses might do better spreading depreciation over future years by not electing either bonus depreciation in ’04 or first-year expensing. The same thinking might apply to shifting income to tax years with a relatively lower tax rate, perhaps because of the effects of alternative minimum tax in particular years.

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