Bonus depreciation allows an immediate first year deduction on a percentage of eligible business property. Thanks to a taxpayer-friendly provision included in the recently enacted tax reform package, bonus depreciation has been expanded to 100% for qualified property placed into service after Sept. 27, 2017 and before Jan. 1, 2023. And, for the first time, bonus depreciation also applies to used property – as long as it is new to the taxpayer – a break from the past practice of qualifying only “original use” property.
Depending on your tax situation, you can elect to continue to use the previous law’s rules of 50% bonus depreciation for your first tax year ending after Sept. 27, 2017. Beginning in 2023, the new bonus depreciation provisions will be phased out by 20 percent, then 40 percent in 2024, 60 percent in 2025, 80 percent in 2026 and 100 percent in 2027 when it is removed completely.
What is Qualified Property?
Qualified property is defined as tangible personal property with a recovery period of 20 years or less under the new law. Again, under the new law, used property is eligible for bonus depreciation, as long as the taxpayer has not previously used the acquired property and the property was not acquired from a related party. This is a very beneficial change in the new tax law that will create more deductions for taxpayers. Additionally, components of purchased buildings can now qualify for bonus depreciation.
The best way to take advantage of the expanded deduction in relation to buildings is to have a cost segregation study performed. This study will break out the qualified property for which you can now deduct at the 100% bonus depreciation rate.
Bonus Depreciation or the Section 179 Deduction: Which is Best?
It is important to weigh the advantage of taking bonus depreciation versus the Section 179 deduction when determining your tax situation. The Section 179 deduction for tangible personal property allows taxpayers to claim write-offs up to $1 million from $500,000. The phase-out threshold has also increased to $2.5 million.
Both bonus depreciation and Section 179 provide significant advantages for increased tax deductions and cash flow. Net taxable income is not required to take bonus deprecation as it is with Section 179. New net operating loss limitations will also factor into how much bonus depreciation should be taken. Additionally, small businesses benefit more from Section 179 because of the purchases limit and phase-out rules whereas large businesses can benefit from bonus depreciation.
In any case, it is in the taxpayer’s interest to plan for the correct deduction.
Tax Planning Considerations
It is important to remember that claiming bonus depreciation on qualified property is automatic, meaning you need to elect out of bonus depreciation if you do not wish to take the extra deductions. If you miss the election and take regular depreciation, the IRS still calculates as if the bonus depreciation is taken which may result in leaving money on the table.
Given the limitation on the business interest deduction under new law, certain businesses may not want to maximize depreciation deductions in order to deduct all of their interest. You can pick and choose which asset classes to apply the new bonus rules to.
An additional note—bonus for like-kind exchanges, trade-ins or involuntary conversions occurring between Sept. 28, 2017 and Dec. 31, 2017 will only apply to the cash paid since the adjusted basis of the old assets is still governed by the old law.
It remains to be seen if states will decouple from the increase in bonus depreciation, as they have with the previous bonus depreciation limits and Section 179 depreciation.