Depreciation under the TCJA, including Bonus Depreciation
It is crucial for small business owners to be aware of some of the new changes in the Tax Cut and Jobs Act ( TCJA), as these changes can help small businesses initially pay less in taxes. New changes under the TCJA allow small businesses to enjoy bonus depreciation in the first year, of up to 100% of the amount, instead of depreciating the asset gradually over its life. The TCJA also made some changes to Section 179, which allows you to rapidly depreciate business expenses for things like equipment and machinery. However, some of the benefits offered under this program will begin to phase out in 2023 before being eliminated in 2017. Businesses should take advantage of some of the remaining benefits in 2023, as these benefits are poised to decrease in subsequent years. This article will explain some of the benefits of the TCJA, which encourages businesses to make capital investments by offering favorable tax incentives.
Overview of the TCJA
The Tax Cuts and Job Acts allows small business owners to fully deduct various types of asset purchases during the first year. This law applies to any qualifying property that the business began using as of September 2017 and allows business owners to receive a 100% deduction for this property until the end of 2022. Before this act, businesses were allowed to use a 50% bonus depreciation rate and then had to depreciate the remaining 50% over the life of the asset. Other types of qualified improvement property can fall into this category, including office equipment, software, vehicles, and improvements made to non-residential buildings. Furthermore, the TCJA also creates special rules that allow used equipment purchases to be eligible. Unless anything changes, the bonus depreciation benefits will begin phasing out in 2023 and end in 2027.
What are the Benefits?
The TCJA of 2017 improves upon the foundation of Section 179 and bonus depreciation benefits. These changes can provide a wide variety of benefits for small business owners that want to take advantage of bonus depreciation to lower their income tax immediately after making the asset purchase.
Simplify reporting: For many small business owners, it is simpler for them to fully depreciate equipment during the first year. This can simplify the tax filing process in the future, as the business will not need to worry about depreciating an asset over multiple years.
Reduce tax burden: One of the clear benefits of the TCJA is to help small business owners lower their tax burden by depreciating assets more rapidly. The TCJA helps businesses who are unsure about their ability to make certain investments, as the lower income tax during the first year can help to offset the expense of the asset purchase.
Promoting investments: The TCJA can help encourage companies to invest in the near future, as they can enjoy special tax benefits in equipment that can help their business grow. Furthermore, there is more flexibility to allow businesses to purchase used equipment and still be eligible for these benefits.
What Does it Cover?
Many small business owners have used bonus depreciation before and should note that the TCJA improves this process by adding new types of assets and approving greater deductions. During 2015-2017, the maximum bonus depreciation allowed was only 50%. Under the TCJA, the process is the same, but the only difference is that small business owners were able to depreciate the asset by 100% during the first year in 2022, and they will still be eligible to depreciate an asset by 80% if the asset is placed into service in 2023.
Tangible Property: According to the IRS, any tangible property needs to be a MACRS property with a recovery period of 20 years or less to be eligible for the 100% bonus depreciation. The TCJA specifies that tangible property does not include cash and cash equivalents, gift certificates, tickets, vacations, meals, lodging, and other similar items.
Film/Television/Theatre: Moreover, this new act also allows bonus depreciation for other types of film, television, and theatrical productions. All of these categories are defined in Sections 181 D and 181 E of the Internal Revenue Code.
Computer Software: The new changes under the TCJA also cover any type of computer software that is depreciable, as listed under section 167(f)(1) of the Internal Revenue Code.
Vehicles: The TCJA also covers cars, vans, and trucks that are used for business purposes, and removes some of the limits previously in place. The vehicle needs to have a useful life of 20 years or less.The maximum depreciation allowed for vehicles is as follows:
● 1st year: $10,000
● 2nd year: $16,000
● 3rd year: $9,600
● Subsequent years: $5,600
Computers and peripheral equipment: The IRS no longer classifies this equipment as listed property, which makes it easier for businesses to fully depreciate these assets. However, this only applies to assets purchased and placed into service after December 31, 2017.
Fire protection systems, roofs, HVAC, and security systems: The TCJA also expands the definition of Section 179 property to include fire protection systems, roofs, HVAC, and security systems as eligible. These improvements will be categorized similarly to other qualified investment property improvements.
Used Equipment Purchases: One of the major changes implemented during the TCJA included the ability for businesses to apply these benefits to the purchase of used equipment. The changes under the TCJA apply to any used property purchased and put into service after September 27, 2017.
Acquisitions are now eligible: Small businesses can use bonus depreciation for new construction, renovations, and acquisitions. In the past, bonus depreciation was only available for companies that were completely new projects or renovating existing projects. Any acquisition is eligible if the company signed the written binding contract after September 27, 2017.
Section 179 vs. Bonus Depreciation
The changes under the TCJA apply to bonus depreciation and Section 179 and vary depending on the type of asset or industry.
Section 179 and bonus depreciation share many similarities, but there are key differences to note:
● Section 179 is based on a set dollar amount, while bonus depreciation is based on a % of the asset’s value.
● There is technically no limit to bonus depreciation, as it is based on the % of the asset value. Section 179 has a dollar limit amount, which was increased under the TCJA.
● Bonus depreciation can be used to create a net loss, while Section 179 has a limit and can’t be used by small businesses to create a net loss.
Small business owners may be able to combine both in some cases. Section 179 is very flexible, as small businesses can use Section 179 to deduct a set amount during the first year and then allow the asset to continue to depreciate in subsequent years. However, small business owners who use bonus depreciation have to deduct the entire amount (80% in 2023).
Recapture Provisions
Small business owners should be aware of various recapture provisions that could be enforced if they dispose of an asset after using bonus depreciation for the tax benefits during the first year. Any gains that a small business owner experiences after selling a property in the future will be taxed at the regular income tax rate instead of the reduced capital gains tax rate. Small business owners who do not plan accordingly could be faced with an unexpected tax burden if they do not plan appropriately and sell a qualified property.
Small business owners may be able to consult their accountants about using a 1031 gains form to help offset this. This form allows an individual to defer paying the capital gains tax on the asset if they invest it in a similar type of property. Individuals, C Corporations, S Corporations, partnerships, LLCs, trusts, and other businesses are eligible to use Form 1031.
Placed in Service vs. Purchase Date
It is imperative to note that the qualified property must be placed into service by the deadline. If you purchase equipment or another asset before the deadline but do not begin using it, then the purchase would not be eligible for the deduction available for that period. For example, any small business owner who purchased equipment in December 2022 would need to prove that they began using this equipment before 2023 to be eligible for the 100% bonus depreciation. Small business owners who are banking on the 80% deduction that is still available should ideally plan to purchase this asset in Q3 or Q4 2023 to meet the deadline.
Changes Beginning in 2023
One of the main changes that small business owners need to be aware of is the 20% phase-down for bonus depreciation that was implemented on January 1, 2023. Under this new plan, small business owners will no longer be able to fully expense qualified property. However, small business owners are still eligible for 80% bonus depreciation in 2023, and for smaller amounts in subsequent years. The percentage deduction will decrease by 20% each year until it is eliminated completely in 2027. Below is a list of the maximum deduction allowed in each year:
● 2022 and previous years: 100%
● 2023: 80%
● 2024: 60%
● 2025: 40%
● 2026: 20%
● 2027: 0%
Many types of assets that business purchases will be eligible for an 80% tax deduction in 2023, as long as they are placed into service before the end of 2023. There are also special laws for aircraft, as this topic can be more complicated. For example, there is a one-year extension available for certain aircraft purchases, provided that the aircraft’s purchase price is above $200,000 and the buyer pays a 10% non-refundable deposit. Therefore, a small business that purchases an aircraft in 2023 under these conditions will still be eligible for 100% bonus depreciation.
Improvements to Section 179
The TCJA expands the previous definition of Section 179 property by allowing businesses to include improvements made to nonresidential real estate. Qualified improvements include improvements that a business owner makes to the interior of the building. However, certain types of improvements do not qualify under the TCJA, including enlarging a building, constructing an elevator, and improving the internal structural framework.
The new law also increased the eligible deduction amount. The maximum deduction amount increased from $500,000 to $1 million, and the phase-out threshold increased from $2 million to $2.5 million. The IRS also decided to adjust this amount based on inflation in the future.
The following conditions need to be met for businesses who want to use bonus depreciation for non-residential real estate:
● It must be made under lease
● It must be set for occupancy
● The improvement needs to be made three years after the building was first put into service
There are other differences that small business owners should note when deciding how to take advantage of the TCJA when determining whether to use Section 179 or bonus depreciation. The Stanard 179 deduction process is more flexible, as you don’t have to depreciate the entire amount. Some small business owners may prefer to gradually depreciate an asset in subsequent years to have tax savings in future years. However, most businesses can benefit from fully depreciating the asset in the first year. In some cases, it may be logical to take advantage of Section 179 and bonus depreciation if you want to rapidly depreciate an asset.
Specific Industries
Since the changes under the TCJA offer changes to both bonus depreciation and Section 179 depreciation, there are multiple industries that can still benefit from these changes.
Aviation: Aviation companies have unique benefits as they are eligible for a one-year extension if they purchase eligible equipment and put it into service. In this case, the aviation company will need to begin using the plan for commercial flights in the year it was purchased for the airplane to be considered in service. Aviation companies are still eligible for 100% bonus depreciation if they purchase an eligible aircraft this year, while other companies can only use 80% bonus depreciation.
Construction and HVAC: Construction and HVAC companies are also poised to benefit under the TCJA, as companies now receive favorable tax benefits for making upgrades to non-residential properties. This should help to boost demand for these contracting services.
Real Estate: Real estate companies in particular have benefited from the TCJA because of the lower corporate tax rates. These changes particularly benefit REITs ( real estate investment trusts), as there is also a reduction in captive REIT dividend income. Finally, the TCJA also encouraged improvements to non-residential real estate, as businesses are able to rapidly depreciate expenses like roofs, heating, and ventilation.
Manufacturing: The TCJA also allows for rapid depreciation of any type of machinery or equipment used by manufacturing companies, which can encourage them to invest in new assets because of the immediate, first-year tax benefits.
Monitoring Changes
All the information presented in this article is based on the original TCJA passed in 2017, which plans to phase out benefits through 2027. One of the top issues that the NTU is discussing with Congress is phasing out bonus depreciation for qualified assets through 2027. Congress may decide whether to extend or modify the current laws, as the TCJA currently does not allow any bonus depreciation by 2027 and only allows 80% bonus depreciation this year and 60% bonus depreciation in 2024.
Final Thoughts
Small business owners should be aware of the new changes that take place this year. In particular, qualified asset purchases, except for certain aircraft, will only be eligible for 80% bonus depreciation. Any company that needs to purchase office equipment or upgrade non-residential real estate can receive benefits under the TCJA. This should benefit most industries in the United States, although construction and real estate companies are poised to benefit. Based on current laws, small businesses can expect some of these tax benefits to remain in place unless the government makes any legal changes. However, small business owners should move quickly if they want to take advantage of bonus depreciation, as this is maxed out at 80% now, and will reduce to 60% next year.
Sources
https://www.irs.gov/newsroom/tax-cuts-and-jobs-act-a-comparison-for-businesses
https://www.irs.gov/businesses/cost-segregation-audit-techniques-guide-chapter-6-8-bonus-depreciation-considerations
https://www.irs.gov/pub/irs-news/fs-08-18.pdf
https://www.irs.gov/pub/irs-news/fs-08-18.pdf
Section 179 depreciation and MACRS Depreciation Categories
Section 179 and MACRS are two very important depreciation categories that can allow businesses to rapidly depreciate assets in the first year to enjoy tax saving benefits. This article will cover some of the benefits of Section 179 and MACRS depreciation, and explain some of the new tax benefits that were created under the Tax Cut Jobs Act ( TCJA).
Section 179 depreciation
Small businesses can use Section 179 depreciation to depreciate the cost of purchasing a new property and improving the existing property. Under this method, small business owners can immediately expense a deduction rather than capitalizing and depreciating the asset over a set period of time. The benefit of Section 179 depreciation is that it provides the small business owner with immediate tax benefits, as they can fully deduct the total amount during the first year, rather than spreading this out over multiple years. Moreover, there is flexibility for business owners who choose to rapidly depreciate the asset during the first year, and then gradually depreciate the asset in subsequent years. Section 179 depreciation provides small business owners with a unique combination of immediate tax benefits in the first year and flexibility in subsequent years.
Section 179 can help support small business growth and encourage investments in equipment or other assets used to expand their business. The lower taxes paid in the first year can help to offset the higher interest expense from loans to purchase the equipment or from the cash spent to purchase it. For example, if a business purchased $1 million worth of equipment with a 20-year life, they could immediately deduct the $1 million in the first year. The reduced tax burden during the first year could help to immediately offset the cost of purchasing the machinery or equipment.
What Does and Doesn’t Qualify
Section 179 is limited to certain business items, including cars, computers, equipment, and other machinery. Small business owners need to prove that they use all of these assets, including personal vehicles, for business purposes for the majority of the time. According to the IRS, business owners need to prove that these assets are used for business purposes more than 50% of the time.
Equipment: There is a wide variety of business equipment that is eligible under Section 179. Some of this equipment includes machinery, computers, software, and office furniture.
Vehicles: Small business owners can also use Section 179 to depreciate vehicles, even vehicles they use for personal and business purposes.
There are also certain types of investments that do not qualify under Section 179:
● Investment properties do not qualify. However, certain improvements made to non-residential properties can still qualify.
● Land, land improvements, and other buildings
● Gifts and inheritances
Placed in Service vs. Purchase
Small business owners should note that any asset purchased needs to be placed in service during the same year if the company wants to deduct the full amount on their tax returns. While this may not be an issue for purchases like computers or office equipment, which most companies already begin using immediately, small businesses should closely monitor if they purchase other equipment during Q4 2023. For example, the small business should show that they begin using the machinery or equipment shortly after purchasing it for it to be in service.
Changes under the TCJA
The TCJA made some changes to the calculation of depreciation under Section 179, mainly by increasing the eligible amount and adding new types of assets.The IRS also announced that it would adjust these amounts based on inflation in subsequent years after 2018. As of 2022, the maximum deduction amount is $1,080,000, and the maximum value of the property purchased is $2,700,000. These increases apply to tangible personal property, such as machinery and equipment, as well as qualified real property. Qualified real property can include improvements to nonresidential real property, such as roofs, heating or ventilation systems, and fire, alarm, or security systems.
Types of Companies that can Benefit
These changes under the TCJA can benefit companies in multiple industries. Any company with a large office can fully rapidly depreciate typical office expenses, such as computers or office furniture, during the first year instead of in multiple years. Businesses can also improve their offices, including upgrading the heating, ventilation, and air conditioning. Other types of specific businesses that may benefit include the following:
● Agriculture companies can also benefit by using Section 179 depreciation. For example, certain types of agriculture or horticultural structures are eligible, as well as the purchase of livestock.
● Larger manufacturing companies are also poised to benefit from Section 179 depreciation, as machinery or equipment expenses are eligible for this type of depreciation.
● Real estate agents can deduct expenses used to improve their offices or vehicle expenses. Real estate investors can’t use 179 for investment properties but can use it for property upgrades like roofs, heating, and air conditioning units, for example.
It is also crucial to note that companies that can’t afford to buy new equipment are still eligible to use Section 179 depreciation. These businesses can purchase used equipment or lease the equipment and still be eligible.
MACRS
Modified accelerated cost recovery system ( MACRS) is a depreciation system that allows the asset to gradually depreciate over a set period. The MACRS applies to any asset put into service after 1986. MACRS is a useful system because it allows businesses to recover the cost basis of an asset and pay lower income taxes in the first year. The IRS has a predefined useful life of an asset and reduced the useful life of certain assets to allow small business owners to enjoy tax breaks.
MACRS is a solid alternative to straight-line depreciation, which gradually depreciates the asset over its life in equal amounts each year. The straight-line method benefits companies that want gradual tax benefits each year. However, it does not allow small businesses to enjoy strong tax benefits during the initial year they purchase the asset.
Categories
The IRS provides specific guidelines about how certain types of assets fall into different categories. Each category has a different useful life figure, which businesses use to calculate depreciation when they file taxes.
Under this method, businesses can rapidly depreciate the asset during the initial years and then gradually depreciate it over the remainder of its life. This method provides favorable tax benefits during the initial years to help offset the burden of large purchases. It also provides small businesses with tax benefits in subsequent years. This period can be between 3-39 years, depending on the type of asset.
It is also crucial to note that this system can be applied to tangible assets and other forms of intangible assets. For example, patents are also depreciable just like other forms of physical assets like real estate. MACRS is an excellent system for small businesses that want to invest money in capital assets, especially special types of assets that depreciate over a 3-5 year period.
What is excluded: However, there are still certain forms of intangible assets that are excluded from this category. Examples of intangible assets that are ineligible for MACRs include recordings, films, and other intangible properties.
Useful Life
The IRS has clearly established the useful life of certain types of assets, so small business owners must reference this when deciding how to depreciate an asset when they file taxes.
Asset
Useful Life
Tractors, rental property, and racehorses
3 years
Various automobiles, computers, office machinery, furniture, and cattle
5 years
Office furniture, fixtures, agricultural machinery, and railroad tracks.
7 years
Vessel, tugs, trees, and other agricultural structures
10 years
Restaurant property, natural gas distribution line, land improvements, and municipal wastewater treatment plants
15 years
Farm buildings and certain municipal sewers
20 years
Water utility property and certain municipal sewers
25 years
Certain buildings or structures ( 80% of income from dwelling units)
27.5 years
Non- residential Office buildings, stores or warehouses with a class life of fewer than 27 years.
39 years
Businesses must use the information in this table when deciding how to depreciate an asset. Once the small business has determined the cost basis for the asset ( price+ and other expenses like delivery or installation), they can use the information in this table to determine how to depreciate the asset.
Properties with a 3, 5, 7, or 10-year useful life will use the 200% declining balance method, which means that you use 200% of the amount that would be used under the straight-line method. Meanwhile, properties with a 15-year useful life will use the 150% declining balance method.
Conventions
Small business owners also need to determine the convention, which is used to determine how much they can depreciate the asset during the first year. There are three types of conventions that small businesses can elect to use:
● Mid Month: Under this conversion method, you can start depreciating the asset during the middle of the month, even if you purchased it after this date. For example, you can start depreciating an asset in the middle of the month even if you purchased it on the last day of the month.
● Mid quarter: Small businesses who use this method can claim 1.5 months of depreciation if they purchase an asset at any time during a certain quarter, even if it is the last day of the quarter.
● Half year: The half-year method states that an asset is projected to have been in service for half of the year, regardless of when it was purchased during the year.
GPS vs. APS.
There are two types of systems that small businesses can use, which include the general depreciation system ( GDS) and the alternative depreciation system (ADS). Most businesses use the general depreciation system (GDS) when determining how to depreciate assets.
GDS: The general depreciation system is the most common MACRS used to calculate the depreciation of an asset. This method utilizes the declining balance method when calculating the depreciation of an asset. For example, if the depreciation amount is 25% and the asset value is $100,000, the asset will depreciate by $25,000 in the first year and then by $18,750 (0.25*$75,000) in the second year. In this manner, the business can continue to lower its tax burden by recognizing depreciation and can choose to do this more so in the beginning.
ADS: The alternative depreciation system uses the straight line depreciation method. Businesses may choose to use this method because they believe that it is closely connected to the income generated from the asset. Under this method, the depreciation amount is set based on the life of the asset and salvage value so the asset depreciates by an equal amount each year. For example, a company may purchase equipment for $100,000 with a 9-year life and a $10,000 salvage value. The company could recognize depreciation of $10,000/year each year over nine years.
Most businesses will prefer the GDS, as it is more common and allows for greater depreciation in the initial years. There are some cases when using ADS may be legally required. These cases can include the following:
● Tax exempt property
● Tangible property used outside of the United States
● Farming property
● Listed property in a qualified business use ( 50% or less)
Differences in financial statements
Another important fact to note is that the depreciation calculated under MACRS is used to determine income tax paid and is not used in the company’s financial statements. The depreciation methods in the company’s financial statements will likely use other standard forms of depreciation, such as straight-line depreciation.
Final Thoughts
Both MACRS and Section 179 depreciation can be used to help businesses find a depreciation method that can lower their income taxes during the initial years of the asset’s life. These methods can be superior to the straight-line depreciation method, which depreciates the asset in equal amounts each year. The TCJA has provided many benefits for small businesses by reducing the useful life of certain assets ( MACRS) and increasing the amount eligible for Section 179 depreciation.
Sources
https://www.irs.gov/publications/p946#en_US_2017_publink1000107507
https://www.irs.gov/pub/irs-utl/2018ntf-pros-and-cons-of-full-expensing-and-section-179.pdf
