Where has our deduction gone?
February 1, 2010 10:56 AM Subscribe
We formed a LLC. We bought a piece of equipment for the LLC. Why can't we write off the entire cost of the equipment on our 1065?
Let's say we're a t-shirt printing company. We formed in 2009 and we promptly bought a new t-shirt printing machine. We spent $10,000 on the machine and made $700 gross profit in the year. To simplify things, let's say that these two numbers are the only figures on the books. To me, it seems we could claim a loss of $9,300 but our hypothetical accountant has listed a much lower loss- say, $6000. Why?
I figure this has something to do with the deprecation of the machine intersecting with the low profits but I'm not sure. Let's pretend our hypothetical accountant is good with numbers, not words.
Moron-proof answers appreciated.
Let's say we're a t-shirt printing company. We formed in 2009 and we promptly bought a new t-shirt printing machine. We spent $10,000 on the machine and made $700 gross profit in the year. To simplify things, let's say that these two numbers are the only figures on the books. To me, it seems we could claim a loss of $9,300 but our hypothetical accountant has listed a much lower loss- say, $6000. Why?
I figure this has something to do with the deprecation of the machine intersecting with the low profits but I'm not sure. Let's pretend our hypothetical accountant is good with numbers, not words.
Moron-proof answers appreciated.
I'd also suspect that the cost of the printer would be spread of a number of tax years.
posted by jrishel at 11:12 AM on February 1, 2010
posted by jrishel at 11:12 AM on February 1, 2010
Best answer: I am an attorney, but not your attorney. The following is not legal or tax advice and accordingly cannot be used for the purpose of avoiding penalties.
The simple answer is that you didn't lose all the money you put into the machine, so you can't take it as a loss. At the end of the year, the machine likely isn't worth $10,000, but it still has material value.
Accordingly, US tax law only allows you to take as a deduction the amount that represents the diminution in value that the asset suffered during the year. The tax code sets out depreciation schedules for various asset classes that must be followed.
In general, the LLC's earnings have nothing to do with the amount of the depreciation it is entitled to claim.
To get a better sense of this concept generally, you might check out the wikipedia article on depreciation.
posted by dbolll at 11:17 AM on February 1, 2010 [1 favorite]
The simple answer is that you didn't lose all the money you put into the machine, so you can't take it as a loss. At the end of the year, the machine likely isn't worth $10,000, but it still has material value.
Accordingly, US tax law only allows you to take as a deduction the amount that represents the diminution in value that the asset suffered during the year. The tax code sets out depreciation schedules for various asset classes that must be followed.
In general, the LLC's earnings have nothing to do with the amount of the depreciation it is entitled to claim.
To get a better sense of this concept generally, you might check out the wikipedia article on depreciation.
posted by dbolll at 11:17 AM on February 1, 2010 [1 favorite]
Best answer: Speaking hypothetically and very generally, it's not a loss at all. After all, you ended up with the equipment, right?
It's really more of an "expense", no? So the real question is why you can't deduct the entire expense right away, and the answer is that the IRS won't let you. There is a certain logic to the IRS's position here. After all, although you did incur an expense you also ended up with that nice shiny new machine. Doesn't seem right to treat it entirely as an expense right in the first year, does it? Your $10,000 isn't even really an expense -- it's more like an investment. You wouldn't normally think that you'f be able to write off the cost of buying a stock, would you?
You hint at the answer yourself: you have to depreciate equipment rather than taking the entire cost as a deduction up front. The idea is to match your deduction in any given year with the loss of value in the equipment. Of course, you don't want to match anything, but to deduct as much up front as you can. There are ways to accelerate, to a certain extent, the rate at which you deduct the cost of the equipment. This is where your hypothetical accountant comes in.
posted by lex mercatoria at 11:18 AM on February 1, 2010
It's really more of an "expense", no? So the real question is why you can't deduct the entire expense right away, and the answer is that the IRS won't let you. There is a certain logic to the IRS's position here. After all, although you did incur an expense you also ended up with that nice shiny new machine. Doesn't seem right to treat it entirely as an expense right in the first year, does it? Your $10,000 isn't even really an expense -- it's more like an investment. You wouldn't normally think that you'f be able to write off the cost of buying a stock, would you?
You hint at the answer yourself: you have to depreciate equipment rather than taking the entire cost as a deduction up front. The idea is to match your deduction in any given year with the loss of value in the equipment. Of course, you don't want to match anything, but to deduct as much up front as you can. There are ways to accelerate, to a certain extent, the rate at which you deduct the cost of the equipment. This is where your hypothetical accountant comes in.
posted by lex mercatoria at 11:18 AM on February 1, 2010
Dbolll's answer is generally correct.
The machine isn't a total loss; it still has value, whether it made profits for you or not. It is depreciated according to a schedule that the IRS publishes (note that this depreciation schedule is likely different than a simple straight-line depreciation and is specific to the tax code). See here for an explanation.
I assume that your company has retained the services of a qualified CPA. If this is the case, you really, really, really, really need to do that. Like yesterday.
posted by dfriedman at 11:28 AM on February 1, 2010
The machine isn't a total loss; it still has value, whether it made profits for you or not. It is depreciated according to a schedule that the IRS publishes (note that this depreciation schedule is likely different than a simple straight-line depreciation and is specific to the tax code). See here for an explanation.
I assume that your company has retained the services of a qualified CPA. If this is the case, you really, really, really, really need to do that. Like yesterday.
posted by dfriedman at 11:28 AM on February 1, 2010
IANYL, but off the top of my head, this kind of an investment is more likely to be considered a capital expenditure under Sec. 263(a) - that is to say, the cost of the machine is a cost incurred as part of a plan of expansion, modernization, or improvement. Instead of being immediately deductible under Sec. 12, this kind of asset will most likely need to be capitalized, and will instead be deductible at time of sale (though you should also be able to take a deduction under Sec. 167 for wear and tear).
If you've just formed, you might also want to take a look at Sec. 195, which allows limited deduction of qualified start-up expenses for up to $5,000. (In quickly looking through that section, it seems if the machine is properly considered to be a capital asset, then Sec. 195(c)(1)(B) might still bar the deduction - but perhaps you have other qualifying start-up expenses that might fit under this section.)
posted by Pontius Pilate at 11:29 AM on February 1, 2010
If you've just formed, you might also want to take a look at Sec. 195, which allows limited deduction of qualified start-up expenses for up to $5,000. (In quickly looking through that section, it seems if the machine is properly considered to be a capital asset, then Sec. 195(c)(1)(B) might still bar the deduction - but perhaps you have other qualifying start-up expenses that might fit under this section.)
posted by Pontius Pilate at 11:29 AM on February 1, 2010
Here's the good part, the depreciation allows you the tax break next year and the year after, etc., when you may actually be making money.
posted by theora55 at 2:48 PM on February 1, 2010 [1 favorite]
posted by theora55 at 2:48 PM on February 1, 2010 [1 favorite]
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posted by qxntpqbbbqxl at 11:00 AM on February 1, 2010