Section 179 and Bonus Depreciation, A Powerful Combination
Tax planning used to be an exercise that was performed sometime in the fourth quarter. Those days are no longer, as clients need regular consultation and tax planning. One such planning opportunity that is coming up more and more is the potential interplay between Section 179 and bonus depreciation. The Tax Cuts and Jobs Act (TCJA) of 2017 made significant changes to the Section 179 and bonus depreciation provisions. These changes incentivize business taxpayers in acquiring eligible assets that could further accelerate their deductions.
It is important to highlight the interplay between Section 179 and bonus depreciation. As it turns out, the power of effectively claiming both deductions can create bigger benefits taxpayers otherwise might have missed. This is particularly important as we have entered the phase out period of bonus depreciation, with 80% bonus depreciation effective starting January 1, 2023, and will be reduced by 20% each year, and eventually become fully phased out in 2027.
What is Section 179?
Section 179 allows business taxpayers to deduct the cost of certain property as an expense when the property is first placed in service. This deduction applies to tangible property, such as machinery and equipment and/ or software purchased for use in a trade or business. Eligible property also includes qualified real property such as improvements to roofs, HVAC, fire alarm systems and security systems, and qualified improvement property to nonresidential real property.
It is designed to encourage small businesses to invest in themselves by providing a tax incentive, allowing taxpayers to immediate expense the costs instead of recovering the cost over time by taking depreciation deductions.
To qualify for the Section 179 deduction, your property must have been acquired for use in your trade or business. Property you acquire only for the production of income, such as investment property, rental property, and property that produces royalties, generally does not qualify.
Unlike bonus depreciation, there is a deduction limitation and phase out thresholds, which taxpayers need to be aware of. The deduction limit for 2023 is $1.16 million, and the spending cap on eligible purchases is $2.89 million. This means businesses can deduct up to $1.16 million of the cost of qualifying assets that were purchased or financed during the tax year, if the total amount of assets purchased do not exceed $2.89 million. In 2024, the Section 179 deduction limit increases to $1.22 million, with a spending cap on eligible purchases for $3.05 million. If purchases exceed these thresholds, the deduction limit is reduced on a dollar-for-dollar basis.
What is Bonus Depreciation?
Bonus depreciation is a tax incentive that provides an additional first-year depreciation allowance. Business taxpayers can deduct additional depreciation on eligible assets used in a trade or business in the year the assets are placed in service. The TCJA increased the bonus depreciation rate to 100% for qualified property acquired and placed in service after September 27, 2017, and before January 1, 2023, and a 20% phase down period began afterwards, to be fully phased out in 2027.
Before the TCJA, bonus depreciation was limited to new equipment. The law now allows for bonus depreciation on used equipment, though it must be “first use” by the purchasing business. This change has opened up additional opportunities for taxpayers to accelerate depreciation deductions.
Interplay – Section 179 and Bonus Depreciation
Each deduction can individually provide great benefits to the taxpayers but combining them can truly generate a more substantial benefit. Therefore, given the current environment of bonus depreciation phasing out, it is critical to understand the rules and execute the planning process accordingly. IRS rules require that most businesses apply Section 179 first, followed by bonus depreciation.
Example
Taxpayer A acquired equipment in 2024 with a cost basis of $2.5 million. Assuming the equipment has a five-year asset life, by leveraging both Section 179 and bonus depreciation, the potential benefits are illustrated below.
Cost of equipment $2,500,000
Section 179 deduction $1,220,000
Bonus depreciation (60%) $ 768,000
First year depreciation $ 102,400
Total first year deductions $2,090,400
Cash savings on the purchase (37% tax rate) $ 773,448
Please note, state conformity to Section 179 and bonus depreciation can vary.
Thank you to Agatha Li for writing this blog post!
Courtney is a Tax Principal in CLA's Real Estate industry group and has more than 17 years of experience providing accounting, tax and consulting services to real estate owners, operators and developers. She also consults with high net-worth individuals and owners of closely-held businesses on all aspects of tax planning.