A critical component of many businesses’ tax planning strategy is their approach to tax depreciation. Under current tax law, there are multiple ways to take advantage of accelerated depreciation. There has never been a better time to re-evaluate your tax depreciation options now that the first-year benefits of bonus depreciation are decreasing for tax years beginning in 2023.
There are two primary ways to accelerate depreciation under current tax law – Section 179 and bonus depreciation. We will walk through the details of each below so that you can understand what may be right for your specific situation.
Under Section 179, for qualifying property placed in service during tax years beginning in 2023, a business is allowed to immediately expense up to $1,160,000 of the purchase price of the asset rather than depreciating it over its useful life. This amount increases to $1,220,000 in 2024.
Qualifying property includes most types of personal property as well as certain types of real property, such as alarm systems, roofing, HVAC equipment, and Qualified Improvement Property (QIP). QIP is any improvement made by the taxpayer to an interior portion of a nonresidential building. However, improvements that are attributable to the enlargement of a building or the internal structural framework are excluded. In addition, for the real property to be Section 179 eligible, it must be placed in service after the original nonresidential property has been placed in service.
To claim the full $1,160,000 deduction, the total purchase price of all eligible property cannot exceed $2,890,000 for 2023. This amount increases to $3,050,000 for 2024. The amount of Section 179 that can be taken each year is decreased dollar for dollar by the amount the total purchase price of eligible property exceeds the threshold. In 2023, if the total purchase price of eligible property exceeds $4,050,000, then no Section 179 deduction is allowed.
Note that Section 179 cannot cause an overall tax loss and so the expense deduction is limited to taxable income. If the business is already at a tax loss, then Section 179 cannot be taken. And if the business is a pass-through entity, there may be additional considerations.
Under bonus depreciation rules, a business is allowed to immediately expense 80 percent of the purchase price of a qualifying asset placed in service for tax years beginning in 2023. The remaining 20 percent of the purchase price would be depreciated over its useful life. Like Section 179, not all property types are eligible for bonus depreciation.
Unlike the Section 179 deduction, bonus depreciation has no dollar limits and no limitations as it relates to taxable income. So even if the business is already in a tax loss, bonus depreciation can still be taken.
For tax years 2024 through 2026, bonus depreciation will phase out as follows:
- December 31, 2024 – 60 percent Bonus Depreciation
- December 31, 2025 – 40 percent Bonus Depreciation
- December 31, 2026 – 20 percent Bonus Depreciation
Which approach is right for you?
While evaluating which approach is right for you can be complex, one of the first questions to ask is whether you want to accelerate your tax depreciation deduction. If not, there are ways to opt for both Section 179 and bonus depreciation.
If you do want to accelerate depreciation, you may want to look at the amount of qualifying property placed in service or whether you are expecting a taxable loss. If either of these are not within the limits of Section 179, your only option may be bonus deprecation. However, if your business falls within the limits of Section 179 and you are looking to accelerate deductions as much as possible, Section 179 may be the best choice. Note, state impacts should still be considered.
Though this article has discussed the federal treatment in depth, the treatment by states can vary significantly both on Section 179 and bonus depreciation. Some states conform to the federal treatment, some decouple from the federal treatment, and others have their own rules altogether. Evaluate each treatment by state in addition to federal to determine the optimal approach.