As we all may be aware, the 2017 Tax Cuts and Jobs Act (TCJA) benefited businesses by providing 100% bonus depreciation on certain qualified assets. As this provision started phasing out at the end of 2022, businesses should already be thinking about how this will impact their tax planning moving forward.
The 100% bonus depreciation is allowed for property acquired and placed into service after September 27, 2017 and before January 01, 2023. After 2023, the bonus depreciation decreases 20% each year until it is eventually phased out as follows:
- 2023 – 80% for property placed into service
- 2024 – 60% for property placed into service
- 2025 – 40% for property placed into service
- 2026 – 20% for property placed into service
- 2027 and beyond – 0% for property placed into service
Planning for the Future
As bonus depreciation phases out in the next few years, keep in mind businesses will still have the benefit of taking regular depreciation or Section 179 depreciation. At this time, Section 179 depreciation is available in all future years, however it is slightly less attractive than bonus depreciation as there are deduction limitations each year. For 2022, the deduction limit is $1,080,000 (for 2023 – $1,160,000) and the phase-out deduction starts once qualified assets exceed $2.7 million (for 2023 – $2,890,000).
If electing bonus depreciation on section 1250 property (i.e. qualified improvement property, MACRS qualified 15-year leasehold improvement property, and land improvements), depreciation is treated as accelerated depreciation. When the qualified asset is sold or disposed of resulting in a gain, the difference between the amount of the bonus depreciation previously deducted and straight-line depreciation that would have been deducted through the recapture year will be recaptured and reported as ordinary income.
If electing Section 179 depreciation as opposed to bonus depreciation, there are a few key factors to keep in mind: (1) Section 179 deductions cannot result in a tax loss and can only be taken to the extent of taxable income; (2) A business may need to recapture Section 179 if business use drops to less than 50%. If this occurs, the business will need to recapture a portion of Section 179 taken and report it as ordinary income; and (3) If the qualified asset is sold or disposed of prior to the expiration of its life, the business will have to recapture a portion of the Section 179 depreciation and report it as ordinary income. The amount that may be subject to re-characterization is the lesser of (i) the prior deprecation deduction allowed or allowable or (ii) the taxpayer’s gain on the property.
There is a lot to consider now that bonus depreciation is starting to phase out. Moving forward, do you utilize the bonus depreciation that is available in the year you purchase a qualified asset, do you utilize Section 179 depreciation, or do you take regular depreciation? The tax incentives of these depreciation options are only beneficial if they make sense for the business. These are matters that need to be considered, especially during tax planning and should be discussed further with your accountant prior to making a decision.
If you have any questions regarding this important topic, please contact our office for assistance.
Article submitted by Béatrice R. Calen, EA