ST. CROIX INSIGHTS

Navigating the Phase-Out of Bonus Depreciation

BY BRETT ANDERSON/ST.CROIX ADVISORS, LLC
US dollar banknotes over digital screen with exchange chart, depreciation and volatility concept

The first-year bonus depreciation deduction is being gradually phased out. Here’s a strategy to consider: Focus on the Section 179 deduction instead. If you place in-service property that qualifies under Section 179, you can aim for immediate write-offs up to a generous limit. Claiming bonus depreciation may not be necessary.

Understanding Bonus Depreciation

First-year bonus depreciation is available for assets like computers, vehicles (within limits), off-the-shelf software, machinery and equipment, office furniture, and other property depreciable under the Modified Accelerated Cost Recovery System (MACRS), with a recovery period of 20 years or less. You can also claim bonus depreciation for “qualified improvement property” (QIP) in a nonresidential building. For a particular asset, the first-year bonus depreciation deduction is claimed after the taxpayer claims any first-year Section 179 depreciation deduction.

Historical Context

Before the Tax Cuts and Jobs Act (TCJA), the first-year bonus depreciation deduction was equal to 50% of the cost of new (but not used) qualified property placed in service during the year. The TCJA doubled the first-year bonus depreciation percentage to 100% for qualified property placed in service after September 27, 2017, and before January 1, 2023. It also expanded the bonus depreciation deduction to cover used as well as new property.

However, the TCJA phases out first-year bonus depreciation from 2023 through 2026. The allowable percentage for property placed in service in calendar year 2024 is 60%, meaning you’re getting less tax bang for your buck this year than in the past.

Read more: 10 Key TCJA Changes Set to Expire

Leveraging Section 179 Deduction

Fortunately, the phase-out can be a moot point if the property placed in service qualifies for the first-year Section 179 depreciation deduction, which can cover 100% of the depreciable property’s cost.

Section 179 Benefits

A business can write off the full cost of qualified Section 179 property (both new and used) placed in service during the year, up to the lesser of its business income calculated before any Section 179 deductions or an annual maximum that can be subject to a phase-out rule. For tax years beginning in 2024, the maximum Section 179 deduction is $1.22 million, subject to a phase-out at $3.05 million of qualified property placed in service during the year. In many cases, a small or medium-sized business can instantly write off the entire cost of property placed in service in 2024—with no bonus depreciation needed. And if there’s some cost left over, bonus depreciation and regular depreciation can pick up part of the slack.

Decision-Making Considerations

The decision to claim first-year Section 179 deductions or first-year bonus depreciation is not a simple one. Also, most states allow Section 179 and many states did not adopt bonus depreciation

Impact on Pass-Through Entities

For example, if your business is organized as a pass-through entity—such as an S corporation, partnership. Section 179 deductions and bonus depreciation write-offs reduce your qualified business income (QBI). This lowers your QBI deduction. Therefore, if you’re entitled to a QBI deduction, consider the potential tax impact from first-year depreciation deductions.

Net Operating Losses and Future Tax Rates

You can create a NOL with bonus depreciation but not 179. Furthermore, it may be advantageous for your business to forego first-year Section 179 deductions and first-year bonus depreciation if you have a net operating loss (NOL) for the year, an NOL carryover into the year, or expiring tax credit carryovers that could not be used if taxable income is reduced by big first-year depreciation deductions. Also, if you believe tax rates will be higher in future years, depreciating assets over those future years when tax rates are higher could yield greater overall tax savings than claiming first-year depreciation deductions for the current year.

Timing of Deductions

Finally, remember that Section 179 deductions and bonus depreciation can only be claimed in the year in which the qualified property is placed in service—not the year the property is acquired. This is important if you need extra time at year-end to customize and/or install equipment.

Tip: Keep these tax rules in mind when your business purchases depreciable property.

This can be a very complicated tax area. Talk to a qualified CPA about this that specializes in business planning. Shaun Simma, CPA is someone I turn to for advice in the area. His e-mail address is shaun.simma@creativeplanning.com.

 

The first-year bonus depreciation deduction is being gradually phased out. Here’s a strategy to consider: Focus on the Section 179 deduction instead. If you place in-service property that qualifies under Section 179, you can aim for immediate write-offs up to a generous limit. Claiming bonus depreciation may not be necessary.

Understanding Bonus Depreciation

First-year bonus depreciation is available for assets like computers, vehicles (within limits), off-the-shelf software, machinery and equipment, office furniture, and other property depreciable under the Modified Accelerated Cost Recovery System (MACRS), with a recovery period of 20 years or less. You can also claim bonus depreciation for “qualified improvement property” (QIP) in a nonresidential building. For a particular asset, the first-year bonus depreciation deduction is claimed after the taxpayer claims any first-year Section 179 depreciation deduction.

Historical Context

Before the Tax Cuts and Jobs Act (TCJA), the first-year bonus depreciation deduction was equal to 50% of the cost of new (but not used) qualified property placed in service during the year. The TCJA doubled the first-year bonus depreciation percentage to 100% for qualified property placed in service after September 27, 2017, and before January 1, 2023. It also expanded the bonus depreciation deduction to cover used as well as new property.

However, the TCJA phases out first-year bonus depreciation from 2023 through 2026. The allowable percentage for property placed in service in calendar year 2024 is 60%, meaning you’re getting less tax bang for your buck this year than in the past.

Read more: 10 Key TCJA Changes Set to Expire

Leveraging Section 179 Deduction

Fortunately, the phase-out can be a moot point if the property placed in service qualifies for the first-year Section 179 depreciation deduction, which can cover 100% of the depreciable property’s cost.

Section 179 Benefits

A business can write off the full cost of qualified Section 179 property (both new and used) placed in service during the year, up to the lesser of its business income calculated before any Section 179 deductions or an annual maximum that can be subject to a phase-out rule. For tax years beginning in 2024, the maximum Section 179 deduction is $1.22 million, subject to a phase-out at $3.05 million of qualified property placed in service during the year. In many cases, a small or medium-sized business can instantly write off the entire cost of property placed in service in 2024—with no bonus depreciation needed. And if there’s some cost left over, bonus depreciation and regular depreciation can pick up part of the slack.

Decision-Making Considerations

The decision to claim first-year Section 179 deductions or first-year bonus depreciation is not a simple one. Also, most states allow Section 179 and many states did not adopt bonus depreciation

Impact on Pass-Through Entities

For example, if your business is organized as a pass-through entity—such as an S corporation, partnership. Section 179 deductions and bonus depreciation write-offs reduce your qualified business income (QBI). This lowers your QBI deduction. Therefore, if you’re entitled to a QBI deduction, consider the potential tax impact from first-year depreciation deductions.

Net Operating Losses and Future Tax Rates

You can create a NOL with bonus depreciation but not 179. Furthermore, it may be advantageous for your business to forego first-year Section 179 deductions and first-year bonus depreciation if you have a net operating loss (NOL) for the year, an NOL carryover into the year, or expiring tax credit carryovers that could not be used if taxable income is reduced by big first-year depreciation deductions. Also, if you believe tax rates will be higher in future years, depreciating assets over those future years when tax rates are higher could yield greater overall tax savings than claiming first-year depreciation deductions for the current year.

Timing of Deductions

Finally, remember that Section 179 deductions and bonus depreciation can only be claimed in the year in which the qualified property is placed in service—not the year the property is acquired. This is important if you need extra time at year-end to customize and/or install equipment.

Tip: Keep these tax rules in mind when your business purchases depreciable property.

This can be a very complicated tax area. Talk to a qualified CPA about this that specializes in business planning. Shaun Simma, CPA is someone I turn to for advice in the area. His e-mail address is shaun.simma@creativeplanning.com.