Businesses that purchase and install qualified property in 2023 can expect to see changes to bonus depreciation this year as deduction rates begin to phase out. Since 2017, The Tax Cuts and Jobs Act (TCJA) incentivized businesses to acquire capital equipment by allowing an immediate 100 percent bonus depreciation on the cost of eligible assets in the first year placed in service. Now, after five years, the percentage of bonus depreciation begins to phase down from 100 percent to 80 percent and will continue to decrease by 20 percent for ensuing years through 2026, and phase out completely in 2027.
Even though the sun has set on 100 percent bonus depreciation, businesses still have an opportunity to leverage this valuable tax-saving tool and deduct 80 percent of qualifying property placed in service after Jan. 1, 2023 and before Jan. 1, 2024.
Under current law, qualified property is defined as a depreciable asset with a recovery period of 20 years or less, such as vehicles, machinery, equipment, furniture, and computers, as well as some film, television, and live theatrical production. First-year bonus depreciation is available for new and most used property, though used property must not have been used by the business prior to acquisition, meaning it must be new to the business.
Qualified improvement property also qualifies for bonus depreciation and includes interior improvements to non-residential property, except elevators, escalators, or structural changes or expansions.
As businesses consider taking advantage of this deduction and weigh purchasing decisions, it’s important to note that the key to eligibility is to ensure that the qualifying assets are placed in service by the end of the year; otherwise, the qualifying property will only be eligible for the succeeding year’s bonus depreciation phase-out amount. For example, if a business purchased a new piece of machinery in 2023, but it was expected to be placed in service for a job that started in 2024, the business would then need to wait until it filed its 2024 income tax return to claim bonus depreciation, which decreases to 60 percent next year.
Section 179 and Bonus Depreciation
Businesses can also pair Section 179 deductions—currently capped at $1.16 million—with bonus depreciation on most qualifying new and used property. Section 179 deductions are gradually phased out when expenditures exceed $2.89 million.
Because bonus depreciation is an additional first-year depreciation allowance, it can be calculated alongside other depreciation methods, such as Section 179 expensing, and go beyond traditional allowances. When used together, businesses may be eligible to deduct the full purchase cost of qualifying property on their returns, subject to certain limitations.
While short-term tax saving benefits from bonus depreciation and the expensing election are appealing, it’s important to be aware of the long-term net tax liability of the accumulated depreciation. In the future if the asset is sold, the total amount of depreciation claimed may need to be recaptured as ordinary income if the asset is sold for a gain, which may result in an increase in tax liability during the year of sale. Discuss various tax positions with your advisor to project impact and resultant effects in future years.
Cost Segregation Planning Opportunities
In tax years when deduction rates are higher, businesses may consider a cost segregation study to increase the value of bonus depreciation and Section 179 expensing. Performed by a team of engineers, accountants, and construction professionals, a cost segregation study would be able to accurately identify, classify, and calculate all building assets that would be eligible for accelerated depreciation, therefore increasing cash flow and saving you money.
Generally, buildings themselves are depreciated over 27.5 (residential rental) or 39 (commercial) years and are not eligible for bonus depreciation; however, a cost segregation study helps businesses separate out the non-structural components of the building that could qualify. From there, businesses can write off the eligible parts faster, and therefore, qualify for bonus depreciation.
As you consider these changes, be sure to contact your R&A advisor to determine if bonus depreciation is recommended for your situation. While taking accelerated deductions sounds like a home run tax savings opportunity, there could be instances when electing to take them is not advisable.
Establish a plan now so you don’t miss out on the potential tax benefits for 2023.
About this Author
Dave specializes in tax research, estates and trusts, complex partnerships, and corporate, not-for-profit, and private foundation tax compliance.