Planning for the Possible Phase Out of Bonus Depreciation by Joshua P. Heberling, CPA
The 2017 tax cuts introduced a temporary bonus depreciation provision that allowed businesses to immediately write off 100 percent of their costs for new and used qualifying property they placed into service between Sept. 28, 2017, and Dec. 31, 2022. The rate of this first-year depreciation deduction has decreased by 20 percent each subsequent year and is scheduled to phase out entirely in 2027. In 2025, taxpayers may recover only 40 percent of their acquisition costs, and in 2026, the rate is scheduled to drop to 20 percent. While the new administration in Washington, D.C., is considering making bonus depreciation a permanent provision of the tax code, businesses must be prepared to pursue alternative tax-saving strategies should the provisions sunset over the next three years.
Bonus depreciation enables businesses to recover a portion of their qualifying property acquisition costs in the year of purchase rather than taking depreciation deductions over the useful life of those assets, which can be as long as 20 years. This essentially reduces a company’s taxable income and its potential tax liabilities. In fact, this first-year depreciation deduction can create a net operating loss that a business can carry forward to offset income in future years. To maximize the benefits of these deductions, companies must consider 1) the type of property acquired, 2) the original use of the property and 3) the date the taxpayer places the property into service.
Qualifying Property
New and used tangible property with a recovery period of 20 years or less qualifies for bonus depreciation. This includes equipment, machinery, appliances, furniture, fixtures, vehicles, land improvements and qualified improvement property (QIP), which refers to certain non-structural improvements to the interiors of non-residential buildings.
To qualify for the depreciation deduction, the property’s original use must begin with the taxpayer (i.e., new property), or the property may be previously used as long as the taxpayer 1) did not purchase it from a related party and 2) the taxpayer’s basis is not determined by the seller’s adjusted basis in the property. Taxpayers should also be careful to distinguish the date when they purchase the property from the date they place the property into service, since the latter is used for claiming a first-year depreciation deduction. For example, a taxpayer who purchases qualifying equipment in 2025 and has it ready and available for business use in the same year can claim a 40 percent bonus depreciation deduction on their 2025 tax returns. However, if the taxpayer does not put the property into service until next year, the deduction goes down to 20 percent and must be claimed on the taxpayer’s 2026 tax returns.
Planning Strategies
Section 179 of the tax code is a permanent provision that allows taxpayers to claim a first-year deduction for the costs of qualifying business assets, including those covered under bonus depreciation as well as off-the-shelf software and certain improvements to commercial property, such as replacements of roofs, HVACs, alarms and security and fire protection systems, during the first year they are placed in service. However, unlike bonus depreciation, which does not have any annual caps on the dollar amount of the deduction, the Section 179 expense deduction is subject to limitations. For example, in 2025, the maximum deduction is $1.25 million on qualifying property costing less than $3.130 million. These limits are indexed for inflation, meaning they will continue to increase each year.
While taxpayers can take advantage of both a first-year depreciation deduction and a Section 179 deduction, they must plan appropriately when purchasing qualifying equipment to maximize the intended tax savings of each. This is especially true when considering the possibility that the current administration may extend first-year depreciation deductions in the future.
With the continued phasing out of first-year bonus depreciation, taxpayers will be forced to deduct a lower percentage of qualifying properties’ costs in the first year of service and depreciate the remaining value little by little over the assets’ useful lives. Under these circumstances, it may make sense for taxpayers to claim whatever they can of bonus depreciation at a reduced rate and expense any remaining value under Section 179 up to the maximum amount allowable for that year. This strategy also applies if Congress extends first-year bonus depreciation or makes it a permanent section of the tax code at a set percentage of the total asset cost. However, taxpayers should remember they cannot use Section 179 expenses to create a loss. Instead, those expenses may not exceed the business’s income limits. In both scenarios, taxpayers should consider using a cost segregation study to separate all a commercial property’s depreciable assets into smaller components with different cost basis and shorter recovery periods of five, seven and 15 years rather than a building’s standard tax life of 27.5 or 39 years.
About the Author: Joshua P. Heberling, CPA, is a director of Tax Services with Berkowitz Pollack Brant Advisors + CPAs, where he focuses on tax planning and compliance services for high-net-worth individuals and businesses in the commercial real estate, land development and office-market industries. He can be reached at the firm’s Boca Raton, Fla., office at (561) 361-2000 or info@bpbcpa.com.
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