Bonus depreciation + Section 179 deduction

Tax reform changes

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Jeremy Smith, CPA

To stimulate growth and incentivize taxpayers to invest in new capital, Congress made changes in the new tax law related to bonus depreciation and the Section 179 deduction. Both can help you save tax, so we’re breaking down the big changes you need to know about and the benefits to your bottom line.

What is depreciation?  

Depreciation is really talking about what kind of deductions you can receive via depreciation expense and what tax benefit it equates to over time. Essentially, how fast can you write off your asset? Obviously, the sooner you can write it off, the sooner you can potentially save taxes.

For an asset to qualify for depreciation, it must meet the following criteria:

  • Must be used in a trade, business or other income producing activity
  • Must be property you own
  • Must have a determinable useful life
  • Must be expected to last beyond the taxable year of acquisition

Next, you would determine which depreciable tax life does it fall under – 5, 7, 15, 27.5 or 39 years? Once you’ve classified your asset, now you can choose if you qualify for Section 179 or bonus depreciation.

Section 179

The new tax law made changes to the Section 179 deduction, which could be an alternative to taking bonus depreciation (or in conjunction with). Section 179 cannot take your taxable income below zero. So, if you have a loss, you’re not even eligible. The maximum amount you can take under the new tax law is $1 million (up from $500,000 under the old law), which is phased out dollar for dollar once your investment in eligible property starts to exceed $2.5 million (up from $2 million).

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With Section 179, your asset can be new or used – the same as under the old law. The new law also expands the definition of Section 179 property to include tangible property used to furnish lodging as well as improvements made to nonresidential real property, as long as the improvements are placed in service after the date the building was first placed in service. The changes applicable to Section 179 apply to taxable years beginning after December 31, 2017.

Bonus depreciation

Taxpayers may take 100% bonus depreciation on qualified property – up from the 50% limitation under the old law. Qualified property is defined as tangible property with a recovery period of 20 years or less. The new tax law eliminates the need for the asset’s original use to begin with you, but you cannot have purchased it from a related party. There was also intent to apply these new favorable rules to qualified improvement property, but due to a drafting error in the tax bill, we are still waiting on the technical correction that they have promised.

Remember, the new law applies to assets placed in service after September 27, 2017. If you entered into the purchase contract before this date, then you will fall under the old rules. This change to bonus depreciation under the new law is temporary. It applies to assets placed in service from September 27, 2017 through December 31, 2022. Starting in 2023, it drops by 20% per year, so it would be 80% in 2023, 60% in 2024 and so on. It’s then fully phased out by 2027.

Placed in service yearBonus depreciation percentage for qualified property in general/specified plantsBonus depreciation percentage for longer production period property and certain aircraft
Portion of basis of qualified property acquired before September 28, 2017
September 28, 2017 - December 31, 201750%50%
201840%50%
201930%40%
2020None30%
2021 and afterNoneNone
Portion of basis of qualified property acquired after September 27, 2017
September 28, 2017 - December 31, 2022100%100%
202380%100%
202460%80%
202540%60%
202620%40%
2027None20%
2028 and afterNoneNone

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For bonus depreciation, there are no limiting factors based on profit or loss; however, under the new law, you are not eligible if you are in one of the following trades or businesses:

  • Property providing certain utility services
  • Property used in a real property trade or business that makes an irrevocable election out of the interest expense deduction limitation under section 163(j)
  • A business that has “floor plan financing indebtedness” – for example, a car dealership

Bonus depreciation + business use vehicles

The 2018 depreciation limits on luxury automobiles (6,000 GVW or less) and personal use property also rise. Bonus depreciation increases to 100% as of September 27, 2017 and starts to phase down in 2023. For this article, we assumed 100% business use.

Bonus depreciation on property with 100% business use
Placed in service dateOld lawSeptember 28,2017 - December 31, 2022January 1, 2018 - December 31, 2022
Bonus depreciation percentage50%100%N/A
Phase-outNo limitNo limitN/A
Qualifying propertyNewNew or usedN/A
Maximum deduction - car, truck or van GVWR > 6,000 lbs and < 14,000 lbsNo limitNo limitN/A
Maximum deduction - car, truck or van < 6,000 lbs GVWR (first year)11,160N/A18,000

If you do not elect out, bonus depreciation would add an additional $8,000 to your first-year deduction of $10,000, if applicable. If you do elect out (or are ineligible), your allowable depreciation would be limited to:

  • $10,000 in year one
  • $16,000 in year two
  • $9,600 in year three
  • $5,760 in all subsequent years

Limits apply to any passenger automobile that cost over $50,000 (previously $15,800).

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Bonus depreciation vs Section 179 – additional considerations

There are some things you need to consider in deciding which of these strategies will give you the greatest tax benefit:

  • State conformity. Is your state going to conform to these federal tax changes? If not, that impact to your potential tax savings needs to be considered.
  • Taxable profit or loss. You still need to have profit to claim Section 179. So, if you’re operating at a loss, you cannot create a larger loss via a Section 179 deduction. Bonus depreciation can be taken whether you are profitable or not; therefore, bonus depreciation can be taken to create a larger taxable loss. Note: be aware of the new business loss limitations (not covered in this article) also added by the new tax law.
  • Tax rates. If you’re going to be in a higher tax bracket in three years, you may want to elect out and take your deductions in a year that there’s a higher tax rate because you will get more benefit.
  • Utilization of accelerated depreciation. Basically, can I use my deductions now or not?
  • Integration with other new tax law changes (not covered here): Excess business losses, alternative minimum tax, businesses with floor plan financing, electing farming businesses, certain utility businesses, potential limitations related to business interest expense, etc.
  • Net operating loss rules. These rules have also changed and they may impact any depreciation deduction benefit you will have if taken in 2018 or beyond.

Electing out

Now that you know your options – Section 179 or bonus depreciation – it may make sense for some taxpayers to elect out of any sort of bonus depreciation. For example, maybe you’re already in a net operating loss so you might not be able to utilize the increased deductions.

If you don’t specifically elect out of bonus depreciation, you are assumed to fall into the rule and must take it, so be aware. If you don’t take bonus depreciation, then you follow the depreciable tax life years listed above. Just remember that you can only write off what was actually paid, so it really is a time value benefit – can I take the tax savings now, or will I spread them out over multiple years?

Change is inevitable

Whether you take regular depreciation, bonus deprecation or Section 179, your deductions are all recapturable up to the amount of the depreciation you previously took, but not to exceed your gain if you have a gain upon sale. It’s all about the timing, so talk to your Henry+Horne tax advisor.

Jeremy Smith, CPA, Partner, specializes in consulting, tax planning and compliance work for both individuals and closely held businesses. He can be reached at (480) 839-4900 or JeremyS@hhcpa.com.