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If you ever look at a business tax return or a Profit and Loss Statement for a dental practice, you will undoubtedly see an expense listed as “depreciation” or sometimes “depreciation/amortization.”  And, if you ask a broker or an accountant about that entry, you will probably be told “oh that’s a non-cash expense.”

And, while that statement is true, it probably won’t help you understand any more about your question. So, let’s get down to basics. Many items used in a dental practice are purchased and used in the normal course of business. Dental and office supplies are purchased and used up in a relatively short period of time.

The cost of those day-to-day items used in the business are “deducted” from practice income to determine net income for tax purposes. Other items purchased are said to have “a useful life” longer than the current year of operation of the practice.

Office calculators, small dental instruments, waste baskets, etc. will last several years if not more. However, the cost of these items can be deducted in the year of purchase because of the small unit cost.

A small calculator may last 5 years but, at a cost of $30, it is not necessary to deduct it over its useful life.

However, many items in a dental office have a high cost and a long useful life. A digital x-ray may cost $50,000 and last 10 years. The original idea was that deducting all the cost in the first year would distort the profits for that year so the cost should be spread over the 10 year “useful” life of the item or deduct $5,000 a year as an expense.

That’s the simple part of the story. Our esteemed members of Congress are constantly tinkering and changing our tax laws. So, they came up with several ways to depreciate those “big ticket” items which resulted in the option to deduct some items more rapidly rather than ratably over the useful life.

And, of course, there was uncertainty about the “useful life” of equipment items. What was the “useful life” of a dental chair or a sterilizer? So, the tax wizards had to set up classes of equipment and dictate the “useful life” of everything in each class.

Needless to say, all of this became very confusing. Accountants had to make decisions about how to depreciate an item of equipment and explain it to their dentist clients who usually had no idea what he or she was talking about. And, from time to time, the tax laws were changed and different depreciation methods were mandated.

Some dentists might have had 30 different equipment items purchased over the last 10 years all of which were being written off using different methods of depreciation.

Fortunately, over this past 10 years or so, the whole system has been modified and simplified. At the present time, you can deduct $1,000,000 of equipment cost in the year of purchase subject to certain limits on how much income the practice collects in that year. The amount deducted cannot create a loss in a given year.

For example: if a practice had $800,000 of practice receipts and $600,000 of other practice expenses and it purchased $250,000 of equipment, it could only deduct $200,000 of the equipment in that year with the other $50,000 being carried over to the next year.

In this example, the dentist purchased $250,000 of equipment but the tax return will claim an expense of $200,000. So, in this sense, this is a non-cash expense. 

But wait a minute – how was the equipment in question actually paid for? This is generally overlooked by most professionals when they are at the point of actually buying the equipment. Let’s assume the equipment was purchased with a 10-year loan at 5% interest.

Over the 10-year repayment period, the dentist would pay $2,651.64 per month or a total of $318,196.80 of which $68,197.55 is interest and $250,000 is the repayment of the purchase amount. Only the interest is deductible – remember the $250,000 cost of the equipment was deducted in year 1 and year 2.

In this extreme example, the dentist is getting a large tax deduction in the first 2 years and then getting no deduction except for the interest over the term of the loan. Most of the time, the dentist’s income will have increased over the 10 years, often significantly, so big deductions in early years may be wasted while in lower tax brackets and should be saved for later years in higher tax brackets.

Get help from your accountant before and after major equipment purchases. It will be well worth it. At Otten-Rey, we can help with that.