James asks:
Several of our analysts believe that 179 deductions should be treated like depreciation because it is an election to take the expense rather than capitalize the expenditure and depreciate the asset over time. I disagree and believe that adding it back may overstate cash-flow. What do you think?
Linda says:
You have stumbled across the weakness in adding back ANY depreciation…that even though depreciation does not represent an outlay of cash, they DO pay for the equipment, vehicles and the like. It takes cash outflow at some point.
Background
If the equipment, vehicle or building is financed, depreciation does not represent cash outlay at all except for any down payment. And since we count the debt payments against them, we really would be double-dinging them if we did not add back depreciation.
But that is true no matter what type of depreciation they use…straight-line, MACRS or the first-year write-off afforded by Section 179.
Section 179 is simply an election to take a much higher amount of depreciation in the year of purpose. The amount of the assets eligible has increased over the years. It was over $250,000 in 2009 and by 2023, was over $1,000,000. It has nothing to do with whether the purchase was paid for with cash or financed. So I could pay $10,000 down on a $200,000 piece of equipment and write-off under Section 179 the full $200,000.
That said, this is true even if I use ‘normal’ depreciation.
Treat it the same if…
So I would not treat regular depreciation one way and Section 179 another way. If it has reduced your starting number, taxable income, add it back. If you are entering all expenses instead of starting with a bottom line, as many AgLenders do for farming operations, check your guidelines as to whether to use the front page depreciation or pick up Schedule K and M-1 depreciation as well. Some AgLenders actually substitute in a different number for depreciation based on amount of equipment or buildings in service. (That has nothing to do with Section 179, but is a general observation on how to handle depreciation).
Since your software will add depreciation back, the only difference is, if by making a more complicated entry for depreciation by finding it everywhere, you feel you will have a better picture of the business. I generally do not think so which is why I recommend going with what is on the page one of the return.
I would, if it is significant, consider if the item purchased is financed. If so, and the down payment is not substantial; or if it is an unusual purchase and I am predicting recurring cashflow going forward, I’d add back depreciation.
Only if the expenditures are significant, recurring and not financed would I hold back adding back depreciation. I have heard this is true, for example, with small equipment rental companies where you can go rent a riding lawn mower or a chain saw. If those companies buy all of the equipment they rent to customers out of cash flow, clearly it would be misleading to add back deprecation. Please note, though, I am still treating regular and Section 179 depreciation the same.
Treat it differently if…
With a pass-through entity (1065 or 1120S), Section 179 depreciation does not pass to the front page. It is reported on the Schedule K and, through each K-1, deducted on the owner’s return, not the entity return. If you are starting with taxable income, add back only the depreciation expenses on page one of the 1065 or 1120S. Do not also add back depreciation entries on the K or the M-1.
