4.2 Section 179 expensing and bonus depreciation

Section 179 expensing and bonus depreciation are powerful tax strategies for businesses. They allow companies to deduct the full cost of qualifying equipment and property in the year of purchase, rather than spreading it out over time.

These accelerated deduction methods can significantly reduce taxable income and boost cash flow. However, they come with specific rules, limitations, and strategic considerations that businesses must carefully navigate to maximize their tax benefits.

Section 179 Expensing

Concept and Eligibility

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• Section 179 expensing allows businesses to deduct the full purchase price of qualifying equipment and software purchased or financed during the tax year instead of depreciating it over time
• Eligible property includes tangible personal property used in trade or business (machinery, equipment, vehicles)
• Property must be acquired for business use and placed in service during the tax year for which the deduction is claimed
• Taxpayer must have taxable income from active trade or business to claim the deduction
  • Cannot be used to create or increase a net operating loss
• Limitations apply to total amount that can be expensed in a given tax year
• Phase-out thresholds based on total qualifying property placed in service

Special Rules and Considerations

• Sport utility vehicles subject to specific limitations on deduction amount
• Listed property (computers, vehicles) must meet strict business use requirements
• Property used for both business and personal purposes requires allocation of deduction based on percentage of business use
• Certain real property improvements qualify (roofs, HVAC systems, fire protection systems)
• Carryover of disallowed deduction from previous years allowed, subject to same limitations as current year
• Interaction with bonus depreciation must be considered when determining allowable deduction

Maximum Section 179 Deduction

Annual Limits and Adjustments

• Maximum deduction subject to annual inflation adjustments
• Can change from year to year based on tax legislation
• For 2023, maximum deduction is $1,160,000
• Dollar-for-dollar phase-out begins when total cost of qualifying property exceeds $2,890,000 (2023)
• Deduction limited to taxpayer's aggregate taxable income from active conduct of any trade or business during tax year

Calculation and Special Situations

• Calculate maximum deduction: $Maximum Deduction = Lesser of (Section 179 Limit, Qualifying Property Cost, Taxable Business Income)$
• Consider any carryover from previous years in calculation
• Special rules for married individuals filing separate returns
  • Each spouse treated as separate taxpayer
  • Deduction limit split between spouses unless otherwise elected
• Controlled groups must allocate deduction among members
• Pass-through entities (partnerships, S corporations) allocate deduction to partners or shareholders
  • Subject to individual partner/shareholder limitations

Bonus Depreciation

Concept and Eligibility

• Allows businesses to deduct large percentage of cost of eligible assets in year placed in service
• Percentage varies based on tax year and legislation
  • Recent years allow up to 100% bonus depreciation for certain property
• Eligible property includes new and used property with recovery period of 20 years or less
  • Machinery, equipment, computers, qualified improvement property
• Not limited by taxpayer's business income
  • Can create or increase net operating loss
• Generally taken after Section 179 expensing but before regular MACRS depreciation

Special Rules and Considerations

• Long production period property may have different placed-in-service dates
• Certain aircraft subject to specific rules for eligibility
• Property placed in service in specific disaster areas may qualify for additional bonus depreciation
• Some states may not conform to federal bonus depreciation rules
  • Requires separate state depreciation calculations

Section 179 vs Bonus Depreciation

Strategic Considerations

• Maximize Section 179 expensing first due to flexibility in asset selection and deduction amount
• Apply bonus depreciation to remaining eligible assets to further reduce taxable income
• Consider current and projected future tax rates when deciding between immediate expensing and depreciation over time
• Evaluate impact on other tax provisions (qualified business income deduction - Section 199A)
• Factor in cash flow considerations and potential limitations on future deductions

Optimization Techniques

• Conduct multi-year analysis to determine most beneficial long-term strategy
  • Minimize overall tax liability across multiple tax years
• Balance immediate tax benefits with potential future deductions
• Consider state tax implications when optimizing federal deductions
• Analyze effect on other tax attributes (net operating losses, tax credits)
• Assess impact on financial statements and loan covenants
• Consult with tax professional to model various scenarios and quantify benefits