Under the Tax Cuts and Jobs Act (TCJA), eligible property acquired and placed in service after September 27, 2017, is eligible for 100% bonus depreciation through December 31, 2022. The clock is ticking, however, to take advantage of this 100% benefit, as the benefit is reduced to 80% beginning January 1, 2023.
TCJA Basics and Bonus
The TCJA allows full 100% expensing of most short-lived capital investments, such as machinery and equipment placed in service after September 27, 2017, for five years. Other certain longer-lived assets are eligible as well (see Qualified Improvement Property next). A 20% phase-down is scheduled over the subsequent five years, beginning January 1, 2023 (January 1, 2024, for longer production period property and certain aircraft). The federal tax reform also eliminated the original use requirement which allows Taxpayers to take bonus depreciation on used property (if certain conditions are met). Prior to September 27, 2017, the rate was 50% for bonus depreciation. Taxpayers still can elect to use the 50% rate if they choose to.
Qualified Improvement Property
Qualified Improvement Property (QIP) includes certain non-structural improvements to the interior of a nonresidential building placed in service after the building was originally placed in service. This type of property is bonus eligible with a 15-year depreciable life.
Some examples of QIP include drywall installation or replacement, ceilings, interior doors, fire protection, mechanical, electrical and plumbing. QIP does not include improvements to the internal structural framework, enlargements to a building and elevators or escalators.
Is there another option for a depreciation deduction?
Tax reform certainly liberalized the rules for bonus depreciation of business property. However, there may be opportunities to get an entire write-off of the cost of an asset purchased using Section 179 expensing. Property eligible for Section 179 is similar to property eligible for bonus. Section 179 was made permanent as part of our tax code with the PATH Act (Protecting Americans from Tax Hikes Act of 2015).
Section 179 has two major limitations when compared to bonus. The first is that Taxpayers are capped on the total amount eligible for write-off. The cap on the deduction for 2022 is $1,080,000 with the total amount of equipment purchased not to exceed $2,700,000. The deduction phases out dollar-for-dollar after $2,700,000 and is entirely phased out at $3,780,000. The second limitation is that in most cases, if a business has no taxable profit, the Section 179 deduction cannot be taken.
What deduction should I take on my tax return, if at all?
Accelerating your bonus depreciation or taking Section 179 will defer tax, which is generally beneficial to most taxpayers. Businesses can recover the costs of depreciable property more quickly doing either. If you are eligible for bonus depreciation or Section 179 and you expect to be in the same or a lower tax bracket in future years, taking the additional deduction is likely a good tax strategy. It’s important to note that the bonus deduction is dropping to 80% starting in 2023.
In some cases, delaying deductions can be the best tax advice. If your business is growing and you expect to be in a higher tax bracket in the near future, you may be better off forgoing the accelerated deductions. Even though your tax bill may be higher than if you had taken the deduction, you will preserve larger future deductions on the property. This approach may be more powerful since these deferred deductions save more tax in a year when you are in a higher tax bracket.
If you are unsure if you qualify for the additional deductions, either bonus or Section 179, on your tax return (or a prior year tax return) or you have questions about other depreciation-related breaks, contact your tax advisor. LBMC’s Tax team will examine all options to ensure we advise you on the most tax-advantageous decision for your business now and in the future.
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LBMC tax tips are provided as an informational and educational service for clients and friends of the firm. The communication is high-level and should not be considered as legal or tax advice to take any specific action. Individuals should consult with their personal tax or legal advisors before making any tax or legal-related decisions. In addition, the information and data presented are based on sources believed to be reliable, but we do not guarantee their accuracy or completeness. The information is current as of the date indicated and is subject to change without notice.