When purchasing equipment, business owners are generally expected to spread the tax deduction over the life of the asset – called “depreciation.” Typically you cannot write off the entire purchase cost of the asset in the first year, however, certain IRS provisions and changes via the Tax Cuts and Jobs Act of 2017 (TCJA) allow businesses to accelerate or fully write off assets if certain elections are made. While there are many similarities between what is commonly called bonus depreciation and Section 179, there are some key differences and changes coming.
What is Bonus Depreciation?
Bonus depreciation was initially enacted in response to the events of September 11th to encourage business investment, and has allowed for varied additional first year depreciation ranging from 30% to 100% of the depreciable basis for qualified property. Bonus depreciation must be claimed unless a taxpayer elects out, and is made separately for each class of property, generally consisting of 3, 5, 7, 10, 15 and 20-year property. The TCJA increased first-year bonus depreciation to 100% for tax years 2018 – 2022 but is being phased out by 20% in each of the next 4 years.
Bonus Depreciation Key Points
- No annual deduction limit. As will be discussed later, Section 179 has an annual maximum deduction, bonus depreciation does not.
- Can be greater than business income. Section 179 deductions are limited to business income, while bonus depreciation is not. Net operating loss (NOL) considerations should be made if taking a loss.
- Less flexible than Section 179. Bonus depreciation must apply to 100% of the cost of all assets within an asset category.
What is Section 179?
Internal Revenue Code Section 179 allows businesses to fully expense the purchase price of qualifying equipment purchased during the tax year, limited to a maximum deduction of $1,160,000 for 2023, up to the business’ net income. Additionally, Section 179 begins to phase out dollar-for-dollar if more than $2,890,000 in qualifying assets are purchased. For example, if $3,000,000 of qualifying property is purchased, the maximum has been exceeded by $110,000, and the maximum Section 179 expense will be $1,050,000.
Qualifying assets are tangible physical property not including land and buildings, however under the TCJA certain nonresidential realty improvements may be expensed. This includes “any improvement to an interior portion of a building which is nonresidential real property if the improvement is placed in service after the date the building was first placed in service. Qualified improvement property does not include the enlargement of the building, any elevator or escalator, or the internal structural framework of the building.” Additional specific improvements such as HVAC, roofs, and heating are also allowable.
Section 179 Key Points
- Annual deduction limit.
- Greater flexibility than bonus depreciation. Business owners can choose which purchases to take Section 179 deductions for and can even split the deduction on individual purchases.
- Includes real estate improvements. Bonus depreciation does not apply to the previously mentioned real estate improvements.
What is changing in 2023?
|Section 179 Maximum Deduction||$1,050,000||$1,080,000||$1,160,000|
|Section 179 Phase-out Threshold||$2,620,000||$2,700,000||$2,890,000|
|Bonus Depreciation %||100%||100%||80%|
Businesses will continue to enjoy the benefits of Section 179 for the foreseeable future, as well as regular depreciation, which is calculated evenly over a fixed number of years depending on the type of asset. There are no limits on regular depreciation. Additionally, the option to elect the de minimis safe harbor will also still be available. This rule allows a taxpayer to deduct up to $2,500 for tangible property ($5,000 if applicable financial statements prepared), regardless of whether the property meets other definitions of a purchase that would otherwise need to be capitalized and depreciated.
It should be noted that businesses can and have always been able to use both bonus depreciation and Section 179 in the same year, but with 100% bonus depreciation this consideration has been less important in recent history. Additionally, while many states follow the federal bonus depreciation rules, certain states decouple them and may make changes to their tax code independent of federal regulations. This means that in some cases your state taxable income may be larger than your federal taxable income.
Bonus Depreciation Phase Out
Bonus depreciation is being phased out from the years 2023 – 2026, decreasing by 20% each year. The bonus depreciation phase-out will apply to both new and used property, with the same qualifications in place during the phase out period. Initially enacted as a short-term incentive to spur investment by small businesses, the current phase-out is considered permanent for the time being, though it could be reinstituted by future legislation.
- Tax year 2023: Bonus depreciation rate is 80%
- Tax year 2024: Bonus depreciation rate is 60%
- Tax year 2025: Bonus depreciation rate is 40%
- Tax year 2026: Bonus depreciation rate is 20%
- Tax years 2027 & later: Bonus depreciation rate is 0%
This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied upon for tax, legal, or accounting advice. If you have any questions about depreciation or other tax planning strategies, please do not hesitate to contact us at Lear & Pannepacker.