How is buying equipment/depreciation a tax advantage?

[Bonus131]

Company I work for says there accountant says they need to buy new vehicle/equipment to reduce Taxes (using 100% depreciation)?     I'm confused how this works, and if it is a longterm benefit ?     Anyone know how explain the benefit to me...  

Do you get to 100% depreciate the first year,  and do the payments also get counted as a expenses the following years?

If not I don't see the benefit,  example if company makes $100K profit in year and pay 25% tax, would owe $25k...   If they buy $100k in equipment (say its financed for 4-5 years) and depreciate it 100% year one ; now profit $0 and taxes $0 for year one?    But then year two thru five your paying lease payments of $20k+/year on that equipment and have no depreication on those years? (unless lease payments are a tax expense)...   

What am I missing...

[Just-Lisa-Now-]

Well, 100K in profit (depending on the business structure) may end up costing more than 25% in taxes once federal, state and any self employment taxes get figured in.

If they are in need of a piece of equiment that they may be planning on purchasing in the near future anyhow, it may be a good time to do it before year end.

Everyones tax situation is different, whether it make sense to buy this asset is something the accountant should be able to explain based on their particular situation.  Depreciation doesnt have to be taken all at once, there are several different planning opportunities that are available.

[sjrcpa]

Generally you can only depreciate equipment that you own. So you can't take bonus depreciation in Year 1 and deduct lease payments, too. There is an exception for certain leases where you are treated as owning the property. There, you claim depreciation and don't deduct the lease payments. There is no double dipping.

[qbteachmt]

Let me help with this part, because I really do teach it: "Anyone know how explain the benefit to me"

There are Two Words to learn: Depreciation and Amortization

Depreciation is "the value lost as wear and tear over time" which gets to be taken as Expense. Think of printer paper or electricity; you pay every month, all the time, for the use of it, and it is essentially gone = Poof! All used up, each period that you are billed and you pay. That isn't true for Assets. An Asset is an item of significant value that you still own over time, but it wears out, or loses some value, over its lifecycle. The IRS refers to this as Useful Life. For instance, some real estate is computed on 27.5 years and some on 39 years. That means each year of that useful life, you get to deduct a small portion of your Cost (basis, or original investment), factored out.

Now, also think about how Real Estate is not All Gone, at the end. It's usually still right there. That has Residual Value, then. At the end of its useful life, you don't go to Zero. There is some equipment that completely wears out and some that doesn't.

Now consider Vehicles, such as a specialty truck (drilling rig, tow truck, truck-mounted vacuum, etc). If I buy that sort of vehicle, use it during its useful life, and take depreciation expense (not real dollars, but the IRS formula for the wear-and-tear consideration over the time I use it in my business), you know I can later sell it for some value. If my Books show I depreciated it to Zero, but I end up selling if for some value, then I have a bit of Gain on that sale to report.

When you take the depreciation, that is a computed "allowance" and does not relate to what it cost you to Finance the thing, or to Lease it. The finance or lease is part of Cash Flow. Because some people cannot afford to buy what they need, they lease or finance it, which is the most expensive way to own/operate equipment, because it includes the financing cost from that lender or the lease terms.

Amortization is the "cost of money over time" or the amount you incur in addition to the actual cost, because you don't pay for something up front. A loan is Amortized = the principal payment is one component and the interest is the other component to your monthly payment.

Let's put it all together:

You buy a $100,000 truck but finance it. Over time, then, you might get to Depreciate it on the books and for taxes, and over time the loan terms or Amortization schedule might show the total you will repay over the life of the loan is more like $175,000 due to interest incurred against the initial loan you needed.

And if the entity has a 25% tax bracket in that upper tier, the effort of spending (investing) in a new asset that can be fully depreciated might result in something along these lines:

$100,000 basis, $25,000 tax benefit, and $75,000 additional debt cost. You just Lost $50,000, trying to save $25,000 in taxes.

You need new accounting advice.