When a business acquires an asset that will last longer than a year, the cost of the asset must be expensed over time to match the asset’s life instead of being deducted all at once. This treatment increases taxes in the short term, and the tax code has evolved to create many exceptions for the business owner to try to expense more of the asset’s cost sooner rather than later.
An asset is technically defined as any qualifying property that a business acquires to help produce income. To be depreciable, the property must meet these requirements:
- It must be property the business owns
- It must have a “useful life” that can be calculated
- It must be used in your business or income-producing activity
- It must be expected to last more than one year
Common examples of depreciable assets are: tractors, computers, office equipment, cars, office furniture, and appliances.
There are different options as far as what type of depreciation business owners can take. In some cases, certain types of depreciation will speed up the process so the business can receive higher tax deductions faster.
Section 179 of the US Internal Revenue Code allows the taxpayer to elect to deduct the cost of certain assets in one year, rather than depreciating them over a longer period time. Note that in order to qualify for the Section 179 deduction, the equipment must have been purchased and placed into service in the year you are taking the deduction for.
The Tax Cuts and Jobs Act (TCJA) increased the Section 179 benefit for businesses. In previous years, the maximum deduction was $500,000 (adjusted for inflation) with a phase-out threshold of $2 million (also adjusted for inflation.) Under the new tax reform, the Section 179 deduction increased to $1 million and the phase-out threshold also increased to $2.5 million. The list of qualified Section 179 property expanded to include certain depreciable tangible personal property used primarily to furnish lodging (or in connection with furnishing lodging) and improvements made to nonresidential real property (e.g. roofs, heating, ventilation, fire protection and security systems.)
Another depreciation option to consider is bonus depreciation which was also affected by the TCJA. Like Section 179, bonus depreciation is another form of accelerated depreciation. Bonus depreciation allows the taxpayer to deduct 100% of the cost of qualifying property in addition to the regular depreciation allowance that is normally available. In previous years, the taxpayer could only deduct 50% of the cost of qualifying property. The definition of property eligible for 100% bonus depreciation was also expanded to include qualified property acquired and placed in service after Sept. 27, 2017, if all of the following characteristics apply:
- The taxpayer or its predecessor didn’t use the property at any time before acquiring it.
- The taxpayer didn’t acquire the property from a related party.
- The taxpayer didn’t acquire the property from a component member of a controlled group of corporations.
- The taxpayer’s basis of the used property is not figured in whole or in part by reference to the adjusted basis of the property in the hands of the seller or transferor.
- The taxpayer’s basis of the used property is not figured under the provision for deciding basis of property acquired from a decedent.
- Also, the cost of the used property eligible for bonus depreciation doesn’t include the basis of property determined by reference to the basis of other property held at any time by the taxpayer (for example, in a like-kind exchange or involuntary conversion.)
Section 179 and first-year bonus depreciation are just some of the options business owners can evaluate to ensure they are taking full advantage of different tax provisions. There are also times when it’s best to defer tax deductions into future years and not take all the depreciation deductions you can.
Be sure to consult your tax professional to discuss how to leverage the different depreciation options to create the most beneficial tax outcome for your business.