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).
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.
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.
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.
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.
Categorised in: Real Estate
This post was written by Sean Allaband