Act Now to Take Advantage of This Expiring Tax Benefit

Kelvin Tetz

The Tax Cuts and Jobs Act (TCJA) significantly boosted the potential value of bonus depreciation for taxpayers, expanding the deduction to 100 percent in the year qualified property is placed in service through Dec. 31, 2022. Beginning 2023, the amount drops each subsequent year by 20 percent, until bonus depreciation sunsets in 2027.

Deploy Before Year-End

The placed-in-service requirement is particularly critical for those wishing to claim 100 percent bonus depreciation before the maximum deduction amount falls to 80 percent in 2023. With the continuing shipping delays and shortages in labor, materials, and supplies, taxpayers should place their orders promptly to increase the odds of being able to deploy qualifying property in their businesses before year-end.

Bonus depreciation has been available in varying amounts for some time. Immediately prior to the passage of the TCJA, taxpayers generally could claim a depreciation deduction for 50 percent of the purchase price of qualified property in the first year—as opposed to deducting smaller amounts over the useful life of the property under the modified accelerated cost recovery system (MACRS).

Certain Property Improvements, Equipment, Machinery & more

Businesses can take advantage of the deduction by purchasing, among other things, property with a useful life of 20 years or less. That includes computer systems, software, certain vehicles, machinery, equipment, and office furniture. Qualified Improvement Property (QIP), such as interior improvements to nonresidential property, excluding elevators, escalators, interior structural framework and building expansion, also qualifies for bonus depreciation. A drafting error in the TCJA indicated otherwise, but the Coronavirus Aid, Relief, and Economic Security (CARES) Act, enacted in 2020, retroactively made such property eligible for bonus depreciation.

Cost-Segregation Finds Eligible Building Components

Buildings themselves aren’t eligible for bonus depreciation, with their useful life of 27.5 (residential-rental) or 39 (commercial) years—but cost segregation studies can help businesses identify components that might be. These studies identify parts of real property that are tangible personal property. Such property has shorter depreciation recovery periods and therefore qualifies for bonus depreciation in the year placed in service.

Bonus Depreciation vs. Section 179 Expensing

Taxpayers sometimes confuse bonus depreciation with Section 179 expensing. The two tax breaks are similar, but distinct. Like bonus deprecation, Section 179 allows a taxpayer to deduct 100 percent of the purchase price of new and used eligible assets. Eligible assets include software, computer and office equipment, certain vehicles and machinery, as well as qualified improvement property. But Section 179 is subject to some limits that don’t apply to bonus depreciation. For example, the maximum allowable deduction for 2022 is $1.08 million.

In addition, the deduction is intended to benefit small- and medium-sized businesses so it begins phasing out on a dollar-for-dollar basis when qualifying property purchases exceed $2.7 million. In other words, the deduction isn’t available if the cost of Section 179 property placed in service this year is $3.78 million or more.

No Brainer….Caveats

At first glance, bonus depreciation can seem like a no-brainer. However, it’s not necessarily advisable in every situation. For example, taxpayers who claim the qualified business income (QBI) deduction for pass-through businesses could find that bonus depreciation may not be ideal. The amount of your QBI deduction is limited by your taxable income, and bonus depreciation will reduce this income. Like bonus depreciation, the QBI deduction is scheduled to expire in 2026, so you might want to consider maximizing it before then.

Other Taxable Income Deductions

The QBI deduction isn’t the only tax break that depends on taxable income. Increasing your depreciation deduction also could affect the value of expiring net operating losses and charitable contribution and credit carryforwards. And deduction acceleration strategies should consider tax bracket expectations going forward. The value of deductions is higher when you’re subject to higher tax rates.

Buy Now, Decide Later?

If you plan on purchasing bonus depreciation qualifying property, it may be wise to place it in service before the end of the year to maximize your options.

Kelvin Tetz, CPA, partner, leads the Moss Adams Real Estate Practice and has practiced public accounting since 1998.