Over the years, numerous companies have taken advantage of Section 179 and Section 168(k) of the IRS Tax Code to save on their taxes. In this article, we will provide information about the opportunity for tax savings, the changes to these sections, and considerations to keep in mind in order to benefit from the tax benefits.
Section 179 allows eligible businesses to deduct the full purchase price of qualifying equipment in the year it is put into service. This results in a higher initial expense deduction compared to using standard depreciation methods, which ultimately reduces the company’s tax burden. The eligible equipment can be financed or paid for with cash. To take advantage of accelerated depreciation, the equipment must be put into service before December 31 of the relevant tax year. However, it’s important to note that equipment lead times have been extended in recent years, so considering delivery timing is crucial when planning to utilize these tax breaks. While there are limitations on the amounts and types of equipment, the allowances are substantial enough for many small and medium-sized companies to experience significant savings. The 2018 tax changes brought notable updates to these provisions of the Tax Code. These changes include the ability to deduct the purchase of used equipment (as long as it is “new to you”) and an increase in the limitation amounts. For the tax year 2023, the IRS has increased the maximum deduction and the maximum amount of equipment that can be purchased by approximately 7%.
The Section 179 limits are as follows:
– The maximum amount that can be deducted is $1,160,000.
– The maximum amount of equipment that can be purchased and qualify for the full deduction is $2,890,000.
– The equipment must be placed into service no later than December 31, 2023.
– If the total equipment purchases exceed $2,890,000, the Section 179 deduction decreases dollar for dollar. Once $4,050,000 of equipment is purchased and/or financed, the deduction reaches zero.
Bonus Depreciation, defined in Section 168(k), allows for accelerated depreciation on eligible equipment and property, similar to Section 179. Starting from 2023, the bonus depreciation has been reduced to 80%. Businesses can utilize both Section 179 and Bonus Depreciation allowances, but Section 179 must be applied first. Any amount over the $1,160,000 limit for Section 179 can then be taken as bonus depreciation. As of January 1, 2023, property placed into service is no longer eligible for 100% bonus depreciation, and the deduction has been reduced to 80% for 2023. This reduction will continue annually by 20% until 2027 when bonus depreciation will be eliminated unless there are legislative extensions. It’s important to note that a business must be profitable to take advantage of the Section 179 deduction. However, bonus depreciation currently does not have a business income limitation, allowing businesses to generate a net loss by utilizing this strategy. Businesses should use IRS Form 4562 to record bonus depreciation.
Due to the reduction of the bonus depreciation allowance to 80%, the IRS now allows for “normal” depreciation to be applied alongside bonus depreciation. Normal depreciation applies when the total deduction from Section 179 and bonus depreciation is less than the total cost of the equipment. In this case, the remaining adjusted depreciable basis is subject to normal depreciation. For instance, if a company purchases qualified machinery for a total cost of $1,500,000 and elects to take the Section 179 allowance of $1,160,000, the unadjusted depreciable basis would be $340,000. By taking an 80% bonus depreciation allowance of $272,000, the adjusted depreciable basis becomes $68,000. The remaining $68,000 is then subject to normal depreciation, which in this example would be $13,600 (assuming a 5-year recovery period). This leaves a remaining adjusted depreciable basis of $54,400 for the following year.
Eligible equipment includes heavy machinery, office and computer equipment, off-the-shelf software, and some business-use vehicles, among other items. It is important to consult with a legal or tax advisor to determine if your purchases qualify. The Tax Cuts and Jobs Act (TCJA) expanded the definition of “qualified real property” to include improvements, such as roofs, HVAC systems, fire protection and security systems, to nonresidential real estate. The CARES Act of 2020 further modified the rules for the treatment of Qualified Improvement Property (QIP), classifying it as 15-year property instead of 39-year property and removing it from the $2 million a year limit for Bonus Depreciation.
Before taking advantage of Section 179 and bonus depreciation deductions, it is recommended to consult with a tax or legal advisor. While these deductions can reduce your tax burden for the current year, they may also impact future years’ depreciation, affecting subsequent tax burdens. Additionally, accelerated depreciation can result in a lower book value for the asset, which can influence the debt-to-worth ratio of your balance sheet. This may not have significant consequences for your business, but it could affect your ability to secure loans for future purchases. If you decide to sell the asset at a price higher than the current book value, you may be subject to taxes on the gains from that sale. It is crucial to assess the short and long-term effects of your purchase decisions and tax strategies. Your tax advisor can assist you in evaluating the impacts of these tax strategies, enabling you to make informed decisions. If you are considering purchasing equipment before the end of the year to qualify for Section 179 or bonus depreciation, CCG offers assistance in this regard. Contact us today or explore our financial services for more information. You can estimate your savings with Section 179 by using the “Section 179 Calculator”.
For additional resources on Section 179 and depreciation, you can read a report from the Congressional Research Service about the history of Section 179. The IRS has also published a list of frequently asked questions about Depreciation.
