A Taxpayer’s choice: IRC §179 Expensing vs. IRC §168(k) Bonus Depreciation under the Tax Cuts and Jobs Act (TCJA)
Taxpayers generally have two ways to take an immediate write-off for a portion or all of the cost of an acquired capitalized asset for their business. They can claim a tax deduction for a percentage of the cost of the asset (under IRC §168(k) known as bonus depreciation), or they can claim a deduction for a certain dollar amount of the cost of the asset (IRC §179). Accordingly, taxpayers have the ability to choose whatever works the best for it. However, if a taxpayer elects bonus depreciation, the taxpayer would need to elect the same treatment across the same class of assets (i.e. all five-year MACRS property).
IRC §168(k)-Bonus Depreciation: Under the TCJA, bonus depreciation was increased to 100% of the adjusted basis of qualified property (from 50% previously), and eligible property was expanded to include not only new property, but the acquisition of used property as well (although used property is ineligible in certain circumstances, such as where it was acquired from a related party or there was previous use by the taxpayer).
The amount of bonus depreciation that a taxpayer can claim is not limited to a maximum dollar amount, is not phased out if the taxpayer puts a certain amount of qualifying assets in place in that year, and is not limited to the taxpayer’s business income. Bonus depreciation automatically applies to all eligible properties at their full costs (less any amounts expensed under IRC §179). The taxpayer may elect out of bonus depreciation, but can do so only for one or more full classes of property.
The future first-year bonus depreciation deduction will be phased down, as follows:
- 80% for property placed in service after Dec. 31, 2022 and before Jan. 1, 2024.
- 60% for property placed in service after Dec. 31, 2023 and before Jan. 1, 2025.
- 40% for property placed in service after Dec. 31, 2024 and before Jan. 1, 2026.
- 20% for property placed in service after Dec. 31, 2025 and before Jan. 1, 2027.
IRC §179 Expensing: On the other hand, a taxpayer may, subject to limitations, elect under IRC §179 to deduct (or “expense”) the cost of qualifying property, rather than to recover such costs through depreciation deductions. Under the TCJA, taxpayers can now immediately deduct the entire cost of §179 property up to an annual limit of $1 million (increased from $500,000) adjusted for inflation. However, this annual limit is reduced by one dollar for every dollar that the cost of all §179 property placed in service by the taxpayer during the tax year exceeds a $2.5 million threshold adjusted for inflation.
The TCJA also expanded the definition of IRC §179 property to include the following improvements to nonresidential real property after the date such property was first placed in service: roofs; heating, ventilation, and air-conditioning property; fire protection and alarm systems; and security systems.
Example: Although taxpayers generally benefit by accelerating the timing of deductions, there are situations in which accelerating deductions is offset by other considerations such as expiration of net operating loss (NOL), a charitable contribution, or credit carryforwards.
In Year Y, Taxpayer A buys $2,000 of equipment that is 5-year MACRS property. This is its sole machinery/equipment purchase for the year. The equipment is eligible for IRC §179 expensing and is qualified property eligible for 100% bonus depreciation. Before taking depreciation into account, A has $2,000 of taxable income and a $800 NOL that expires in Year Y.
If A claims 100% bonus depreciation for the equipment, it will reduce its Year Y taxable income to $0. However, this will also allow the $800 NOL to expire unused and reduce A’s future depreciation deductions by $2,000. A can’t elect out of bonus depreciation for part of its 5-year MACRS purchase.
By contrast, if A elects IRC §179 expensing for only $1,000 of the equipment purchase, and elects out of bonus depreciation for the balance of its purchase, it will have $800 of taxable income ($2,000 minus the $1,000 of expensing minus $200 of regular MACRS depreciation (20% × $1,000) for the equipment) before the NOL. Thus, the full $800 NOL will be used, reducing taxable income to $0, while A preserves $800 of future depreciation deductions to be applied against taxable income in future tax years.
Please contact our office to assist you analyze your options of using either IRC §168(k) bonus depreciation or IRC §179 expensing order to maximize the financial impact of the new law on your business. We will help your business determine the best available options to use in order in order to take full advantage of the benefits the TCJA provides for businesses.