Taxes: 179 Deduction

So now, hopefully you understand the basic concept of depreciation. Let's dive into depreciation a little bit more and look at a concept called, or really a part of the tax code called section179. Trust me, you are going to hear about section179 once you buy a practice, because as you work with your suppliers to buy equipment like a dental chair or cabinetry, or to buy an X ray machine or sensors or a CAD cam, there's going to be a lot of incentive that people will share with you to buy that equipment. Because if you do, you can take what's called a Section 179 deduction, which will greatly lower the overall cash outflow. Well, let me step back. Let me make you step back and look at this from the outside in so we understand what's actually happening in the nature of that transaction and what a 179 deduction is. A 179 deduction is simply accelerating the depreciation that you were already going to get. In our prior module, we showed the different depreciable lives of the assets that you buy. The equipment and furniture and computers and leasehold improvements that you buy. Dental equipment is five years. And so let's say you buy that CAD cam for $100,000. Well, over the five years, you're going to get a full $100,000 deduction.

And however, as I mentioned, also that typically that isn't. It's not straight line deduction. So, so let's look at an example here. CAD CAM, $100,000 year one depreciation might be $15,000, year two becomes a big year for depreciation. You get a deduction, which is again, a reduction to your net profits. From a tax standpoint, that's awesome. From a tax standpoint, you want your profits low. Lower profits means lower taxes, which means, happy dentist here, you get to deduct $35,000 in year two. Year three, $25,000, year four, $15,000, year five, $10,000. Now, that's not exact, but I'm rounding here so that you understand the concept of how depreciation occurs. That's your standard depreciation, no section 179. Now, if you take the section 179, something happens, though. You accelerate all five years into the year that you bought that equipment, and you get $100,000 deduction in that year. So let's say your net profits in your corporation were on track to do, let's say, $300,000 for that year, but you bought on December 31st, a CAD cam, and it was placed in your practice, and it was ready to go. And you could elect to take $100,000 off of your profit for the year. And so now you're only taxed on $200,000. And at, let's say, a 40% marginal federal and state tax rate, that just saved you $40,000 that you got to go pay the IRS right now. And so that feels great. And you're looking at your CPA and you're, you're giving them or her a big hug, and you're saying, thank you. Thank you for saving me $40,000.

What's the problem? The problem is that for most of you, you financed that $100,000 machine. You haven't even made your first payment yet. You didn't have a dollar go out of pocket. You got a brand new $100,000 piece of equipment, and you were able to pay the IRS $40,000 less. Sure does feel like a win, win, win. Well, in year one, it does. It's a win, win, win. But what about the rest of the years? Now you're paying $2,500 a month or somewhere around that. And guess what? You know how much tax deduction you're getting? Virtually none. That's right. For five years, you're going to be paying out a bunch of money on a loan and getting virtually no tax deduction. Why do I say virtually? Because the interest portion, let's say, of that $2,500, you might be paying, I don't know, a few hundred bucks, couple hundred bucks in interest, you'll get a deduction on the interest. But like I've said in other modules, the principal portion of any debt is not tax deductible. You're simply paying somebody back money that they let you borrow. And you don't get a tax deduction for paying somebody back. You get a tax deduction on the cost that they charged you to lend you that money, and that's called the interest. But you're getting almost no tax deduction on this outflow every year. That's not insignificant for five years. And it becomes very, very painful.

And when is it okay to take a 179 deduction? I mean, technically you can always take that. But if you have an eye toward planning, you have to realize that the benefit you got in the first year is simply the benefit of, of. It's the summation of all of the benefits you would have got over the five years, all lumped into that first year. And if you take all that benefit now, your tax burden is going to be very difficult in the next year because not only are you not going to get a deduction that gives you that $40,000 savings you got in year one, now you're going to have, you're going to have, I don't know, you're going to have 30,000, $25,000 going out the door that year that you're getting zero tax deduction for. And if there's one thing that is extremely painful for a dentist, it's when you're paying money out the door for something and you don't get a tax deduction for it. But if you paid for that CAD Cam in cash or on credit card, and you paid the credit card off and it literally was money out of your bank right then and there, great, I'm going to tell you, take that 179 and deduct the entire thing. In other words, let's try to match at some level the benefit of depreciation with when you're actually making the payment on that equipment. And if that's through a loan, well, then we should be taking that depreciation over the life of that loan. Here's a five year loan, $100,000 at 6%. You're paying every year, 23,199. If you finance that, as most of you are going to be financing your equipment at 100%, typically we're going to say, let's not take the accelerated depreciation. There are extenuating reasons to do so. At times, if you need a little bit extra deduction to drop you into a certain bracket, which then gives you another deduction or a credit, then you should do that. And that's what good tax planning is, is knowing how to just arrange those levers in your cash flow and when you file your tax return such that you get the maximum optimum output to you economically and you pay the IRS the least amount. So good planning and tax planning means you're not just eyeing this year, you're eyeing next year. And the next year you're looking out, you're planning. Now, I really want to emphasize that.

We want to time that tax deduction because if we don't, then we fall into a tax trap. Because after that first year, let's say you go column two there and you take the 179 deduction and you get the full benefit. But let's say you financed it. So now you've got all these years of paying out. Well, what's going to happen in year two when suddenly not only do you owe $40,000, but now you owe you $40,000 and you have no money in the bank because you were paying on that loan during that year to buy the equipment. What are you going to have to do? You're going to have to go and figure out I need to buy another $100,000 machine. So if I do that, I can take the 179 deduction on that and then that'll help me in this year. Well, that's fine. But then the next year after that. Now you've been paying 45, 40 to $50,000 a year on these two pieces of equipment. You have less money in the bank, more on credit card, and you owe your $40,000 to the IRS. What are you going to do then? Are you going to just keep buying more and more equipment and taking more and more depreciation to get that 179 deduction to save the day? It's a tax trap. It will spiral out of control. And I've seen doctors lose their practices over this. Good tax planning isn't just thinking about the max deduction on depreciation in the year of purchase. It's about thinking strategically the way you acquire that practice through a loan or not, and what your tax bracket is in and how the future is looking over the next year or two within your practice. That is section 179 deduction. I hope you understand that better. In our next module, we're going to talk about what's called a loan to shareholder balance.