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Many companies are eligible for tax write-offs for certain equipment purchases and building improvements. These write-offs can do wonders for a business’s cash flow, but whether to claim them isn’t always an easy decision. In some cases, there are advantages to following the regular depreciation rules. So, looking at the big picture and developing a strategy that aligns with your company’s overall tax-planning objectives is critical.
Taxpayers can elect to claim 100% bonus depreciation or Section 179 expensing to deduct the full cost of eligible property up front in the year it’s placed in service. Alternatively, depending on how the tax code classifies the property, they may spread depreciation deductions over several years or decades.
Under the Tax Cuts and Jobs Act (TCJA), 100% bonus depreciation is available for property placed in service through 2022. Without further legislation, bonus depreciation will be phased down to 80% for property placed in service in 2023, 60% in 2024, 40% in 2025, and 20% in 2026; then, after 2026, bonus depreciation will no longer be available. (For certain properties with longer production periods, these reductions are delayed by one year. For example, 80% bonus depreciation will apply to long-production-period property placed in service in 2024.)
In March 2020, a technical correction made by the CARES Act expanded the availability of bonus depreciation. Under the correction, qualified improvement property (QIP), which includes many interior improvements to commercial buildings, is eligible for 100% bonus depreciation following the phaseout schedule through 2026 and retroactively to 2018. If bonus depreciation isn’t claimed, QIP is generally depreciable on a straight-line basis over 15 years.
Sec. 179 also allows taxpayers to fully deduct the cost of eligible property. Still, the maximum deduction in a given year is $1 million (adjusted for inflation to $1.08 million for 2022), and the deduction is gradually phased out once a taxpayer’s qualifying expenditures exceed $2.5 million (adjusted for inflation to $2.7 million for 2022).
While 100% first-year bonus depreciation or Sec. 179 expensing can significantly lower your company’s taxable income, it’s not always a smart move. Here are three examples of situations where it may be preferable to forgo bonus depreciation or Sec. 179 expensing:
The above rules apply to federal income tax. However, many states have decoupled with either or both bonus depreciation and Section 179 provisions. For example, Illinois no longer allows the bonus depreciation deduction but does follow federal law with respect to Section 179 deductions. So, if you are projecting an overall federal loss, you will want to also project state taxable income to account for the federal to state tax differences.
Keep in mind that forgoing bonus depreciation or Sec. 179 deductions only affect the timing of those deductions. You’ll still have an opportunity to write off the full cost of eligible assets; it will just be over a longer time period. Cray Kaiser can analyze how these write-offs interact with other tax benefits and help you determine the optimal strategy for your situation. You can contact us today at 630-953-4900.