Get Ready to Say Goodbye to 100 Percent Bonus DepreciationTax Planning
Bonus depreciation became a tax thing in 2002, starting with 30 percent depreciation on certain new property.
From January 1, 2015, through September 27, 2017, lawmakers set a 50 percent rate on certain new property.
And then, the big “hip, hip, hooray!” Starting after September 27, 2017, you could claim 100 percent bonus depreciation on (wait for this) both new and used property.
But now, sadly, get ready to say goodbye to the “hip, hip, hooray!”
Starting in 2023 (which is right around the corner), lawmakers scheduled bonus depreciation to decline 20 percent each year, as follows:
Example. If you purchase $100,000 of qualifying equipment for your business and place it in service in 2022, you may deduct $100,000 in 2022 using 100 percent bonus depreciation. If you wait until 2023, bonus depreciation delivers an 80 percent deduction.
Does this mean you should rush out and purchase business property before 2022 ends, to take advantage of the 100 percent bonus? Not necessarily. You likely have an alternative that is not going away and that can be as good as bonus depreciation: IRC Section 179 expensing.
IRC Section 179 Expensing Versus Bonus Depreciation
Both IRC Section 179 expensing and bonus depreciation allow you to deduct in one year the cost of most types of tangible personal property, plus off-the-shelf computer software.2 You can use both methods to deduct
- new and used property acquired by purchase from an unrelated party,3 and
- various types of non-structural improvements to non-residential (think commercial) buildings after they are placed in service.
Moreover, the two deductions are not mutually exclusive. You can apply Section 179 to qualifying property up to the annual limit and then claim bonus depreciation for any remaining basis.
Starting in 2023, when bonus depreciation will be less than 100 percent, any basis left after applying Section 179 and bonus depreciation is deducted with regular MACRS depreciation over several years.
But there are some significant differences between bonus depreciation and Section 179 expensing.
Annual Section 179 Limit
The most significant difference between Section 179 expensing and bonus depreciation is that Section 179 expensing is subject to an annual dollar limit. The Tax Cuts and Jobs Act doubled the limit to $1 million in 2018. The inflation-adjusted limit for 2022 is $1,080,000.6 It is estimated to be $1,160,000 in 2023.
Additionally, because Section 179 is intended to help smaller businesses, there is also a limit on the total amount of Section 179 property a business can purchase each year when claiming the deduction.
You must reduce your available Section 179 deduction by one dollar for every dollar by which your annual purchases exceed the applicable limit. The limit is $2,700,000 for 2022.7 Thus, if you place in service $3,780,000 of Section 179 property in 2022, you have to reduce your available Section 179 deduction by $1,080,000 ($3,780,000 - $2,700,000 = $1,080,000). Net result: you have no available Section 179 deduction.
The Section 179 purchase limit is estimated to be $2,890,000 in 2023.
There is no dollar limit on bonus depreciation. But the Section 179 limits are so large that they don’t impact smaller businesses.
Section 179 Expensing May Not Create a Loss
Section 179 expensing is limited to the annual net taxable income earned by the taxpayer’s business (not counting the Section 179 deduction). This can be misleading for many taxpayers because for the Section 179 deduction, business income includes W-2 income.
The key point is that the Section 179 deduction may not exceed defined business income and still create a loss for the year. Section 179 amounts that may not be deducted are carried forward indefinitely to future years.
Bonus Depreciation Can Create a Loss
Bonus depreciation is unlimited in amount and may result in a business loss. In the past, this was a significant difference because a business could carry a net operating loss (NOL) back to prior years and claim a refund for taxes paid in those years.
But starting in 2021, you may no longer carry NOLs back; you may only carry them forward indefinitely. In addition, NOLs may offset only up to 80 percent of taxable income for any year.
More Than 50 Percent Rule
To qualify for Section 179 expensing, you must use your qualifying Section 179 property more than 50 percent for business. If your business use of the property falls to 50 percent or below during the property’s recovery period, you have to give back some or all of your Section 179 deduction through what the IRS calls “recapture.”
There is no 50 percent business-use requirement for bonus depreciation except for listed property—primarily, passenger vehicles.
Bonus Depreciation Applies Class-Wide
If you use bonus depreciation, you must use it for all assets that fall within the same class. You may not pick and choose individual assets.
Section 179 expensing doesn’t apply class-wide. Thus, you may pick and choose which assets you wish to deduct using Section 179 within the same asset class. This is a potential advantage.
The term “passenger automobile” means any four-wheeled vehicle that is manufactured primarily for use on public streets, roads, and highways, and that is rated at 6,000 pounds unloaded gross vehicle weight or less (think curb weight).
But in the case of a truck, van, SUV, or crossover vehicle, the passenger automobile 6,000-pound rule applies to “gross vehicle weight”—which, in street terms, is generally referred to as the gross vehicle weight rating (GVWR).
Bonus depreciation is limited to $8,000 for such tax code–defined passenger automobiles no matter how much they cost. This limit will be the same in 2023.13 So there is no point in purchasing a defined passenger automobile in 2022 instead of 2023 to take advantage of bonus depreciation.
SUVs and Other Heavy Vehicles
You may use 100 percent bonus depreciation on trucks, vans, SUVs, and crossover vehicles with a GVWR of 6,001 pounds or more. You can also use 100 percent bonus depreciation on cars with a curb weight of 6,001 pounds or more.
In contrast, in 2022, the Section 179 deduction is limited to $27,000 for trucks, vans, SUVs, and crossover vehicles with a GVWR of 6,001 to 14,000 pounds. (The $27,000 limit does not apply to pickup trucks with a bed of at least six feet or to vans that seat more than nine behind the driver.)
For cars, the Section 179 deduction does nothing. Yes, nothing. For cars, it replaces depreciation—so, you get no additional benefit.
The Section 179 expensing limit is estimated to be $28,900 in 2023.
Key point. You can achieve 100 percent bonus depreciation in 2022, but in 2023 bonus depreciation drops to 80 percent. So to get the maximum deduction in 2023, you need a combination of Section 179 expensing, bonus depreciation and MACRS depreciation.
Example. Burt purchases a $50,000 SUV in 2023 and uses it 100 percent for business, which makes for easy numbers. He deducts $28,900 with Section 179 expensing and then $16,880 with 80 percent bonus depreciation (80 percent x $21,100 = $16,880). He depreciates his remaining $4,220 basis using the 200 percent declining balance method, resulting in an $844 deduction. His total deduction is $46,624 ($28,900 + $16,880 + $844).
Had he purchased the SUV in 2022, he would have gotten a $50,000 deduction using 100 percent bonus depreciation.
Most types of real property (i.e., Section 1250 property), including land improvements, do not qualify for the Section 179 deduction. (But you may use Section 179 expensing to deduct interior improvements to non-residential real property.)
In contrast, you can use bonus depreciation to deduct land improvements with a 15-year class life. These improvements include sidewalks, fences, driveways, landscaping, and swimming pools.
When You Should Take Advantage of 100 Percent Bonus Depreciation for 2022
There are a few situations where it may be advisable to purchase and place property in service by the end of 2022 to take advantage of 100 percent bonus depreciation:
- If your business needs to purchase more than $3,780,000 of property, it won’t be able to use Section 179 expensing at all. But you can use 100 percent bonus depreciation if you place the property in service in 2022. When you’re purchasing this much property, an additional 20 percent deduction for 2022 can really add up. If you wait until 2023, you’ll get only 80 percent bonus depreciation.
- If your business needs to purchase more than $1,080,000 in property in 2022, its Section 179 deduction will be exhausted and you’ll have to use bonus depreciation for purchases over $1,080,000. Again, when you’re purchasing this much property, an additional 20 percent deduction for 2022 can really add up.
- If you need to purchase land improvements, you won’t be able to deduct them with Section 179. Purchasing them this year will enable you to deduct them immediately using bonus depreciation.
- If you need to purchase a business-use SUV that weighs between 6,001 and 14,000 pounds, your deduction will be somewhat larger if you purchase the vehicle in 2022 instead of 2023, because bonus depreciation is 80 percent in 2023.
- If you want the maximum possible 2022 deduction for property you use less than 50 percent for business (excluding vehicles and other listed property), you should purchase it this year and take advantage of the 100 percent bonus depreciation.
Keep in mind that it’s not enough to purchase property by December 31, 2022, to claim bonus depreciation or Section 179 expensing. You must also place the property in service in your business by year-end.
You don’t have to actually use the property, but it must be ready for use in your business.
That said, we recommend actual use, such as driving at least one business mile, to eliminate any discussion of “ready for use.”
Here are five takeaways from this article:
- One hundred percent bonus depreciation is ending on December 31, 2022. It will be reduced to 80 percent in 2023 and will decline 20 percent each succeeding year through 2027, when it will be zero.
- Section 179 expensing remains an alternative or supplement to bonus depreciation.
- If you need to purchase a business-use SUV with a GVWR between 6,001 and 14,000 pounds, your deduction will be somewhat larger if you purchase it in 2022 and take advantage of 100 percent bonus depreciation.
- Section 179 expensing is subject to annual dollar limits that don’t apply to bonus depreciation. If your business needs to purchase property over the limits, it will get a 20 percent larger first-year deduction if it does so in 2022 (versus 2023) and takes advantage of 100 percent bonus depreciation.
- Bonus depreciation for passenger vehicles is capped at $8,000 for 2022 and future years, so there is no point in purchasing such a vehicle in 2022 to get a larger deduction.