As the phase-out of bonus depreciation unfolds, taxpayers must carefully reconsider their approaches to accounting for fixed assets. This important tax policy change requires careful planning, and businesses need to optimize their deductions to maintain good cash flow.
This blog will offer an in-depth look at how taxpayers can navigate these changes and adopt advantageous methods for income tax purposes.
Don’t Overlook Possible Tax Advantages for 2024
Companies often get incentives to buy and use capital machinery. The Tax Cuts and Jobs Act (TCJA) of 2017 made important changes to Section 179 and bonus depreciation. These changes still affect tax planning for 2024.
By leveraging both deductions, businesses may deduct up to 100% of capital purchases, provided the equipment falls under the phase-out threshold and qualifies entirely for Section 179 expensing. For equipment exceeding the threshold, bonus depreciation applies at a reduced 60% rate in 2024.
For example, if a manufacturing company plans to purchase $2.5 million in new equipment during 2024, they can take strategic steps to maximize tax savings:
- Section 179 Deduction: Deduct $1.22 million immediately, the maximum limit for 2024 under Section 179.
- Bonus Depreciation: Apply the 60% bonus depreciation rate to the remaining $1.28 million, resulting in a $768,000 deduction.
- Standard Depreciation: Use MACRS to calculate the first-year depreciation for the remaining balance.
The company locks in maximum deductions by ensuring the equipment is placed in service before December 31, 2024. This strategy reduces taxable income, preserves cash flow, and supports future growth.
The Bonus Depreciation Phase-Out Timeline
Bonus depreciation allows businesses to take an additional first-year depreciation deduction on qualifying property. The TCJA originally applied only to new equipment. It now includes used equipment if it is the “first use” by the buying business. Bonus depreciation phases out as follows:
- 2023: 80%
- 2024: 60%
- 2025: 40%
- 2026: 20%
- 2027: 0%
With this phase-out, taxpayers must shift focus from immediate deductions to longer-term strategies for managing fixed assets. These strategies may include using cost segregation studies to classify assets into shorter recovery periods. They also involve using Section 179 deductions for eligible property.
Additionally, timing asset purchases can help optimize depreciation deductions under the remaining phased-out percentages. Additionally, exploring alternative incentives such as energy-efficient property credits or the Research and Development Tax Credit can further mitigate the financial impact.
Understanding Section 179 and Its Recent Modifications
Section 179 is a part of the Internal Revenue Code. It lets businesses deduct the full cost of qualifying equipment or software in the year they buy it. The TCJA raised the Section 179 deduction limit and phase-out threshold. This change makes it more helpful for small and mid-sized businesses.
- Maximum Deduction for 2024: $1,220,000
- Phase-Out Threshold for 2024: $3,050,000
- Eligibility: Applies to new and used equipment, as well as software.
Equipment investments surpassing $4,270,000 are ineligible for any Section 179 deduction, yet they may still be eligible for bonus depreciation.
Key Areas for Review
Placed-in-Service Dates
The timing of when the property is placed in service determines the applicable bonus depreciation rate. For example, property put into service on December 31, 2024, gets 60% bonus depreciation. However, property placed in service just one day later only qualifies for 40%.
According to IRS regulations, you place an asset in service when you make it ready and available for its intended use. Taxpayers should carefully record the facts and details about the placed-in-service date. This helps ensure compliance and maximize deductions.
Recovery Periods
Assigning accurate recovery periods to fixed assets is critical. Shorter recovery periods provide accelerated depreciation, which becomes more valuable as bonus depreciation phases out. For instance:
- Special Tooling Assets: Items like dies, moulds, and jigs may qualify for a three-year life, depending on the industry.
- Foreign Property: Assets used outside the U.S. require the Alternative Depreciation System (ADS), which excludes bonus depreciation. This impacts global tax calculations such as FDII and GILTI.
Taxpayers should revisit asset classifications to ensure recovery periods align with IRS guidelines.
Repairs vs. Capital Expenditures
Properly distinguishing between repair expenses and capitalized improvements is essential. For example, replacing a roof is usually seen as a capital improvement. In contrast, fixing a small part of a roof after storm damage may be considered a repair.
Certain criteria, such as whether the expenditure increases the asset’s value, prolongs its life, or adapts it to a new use can help guide this distinction. Expenditures that improve, adapt, or restore an asset must be capitalized. However, costs that do not meet these criteria can often be deducted as repairs.
With reduced bonus depreciation, this categorization can significantly affect tax liability. Taxpayers should analyze their fixed-asset records to identify opportunities for expense deductions.
De Minimis Safe-Harbor Election
This election allows taxpayers to immediately expense items costing up to $5,000 per invoice (or $2,500 without applicable financial statements).
Reviewing and updating capitalization policies annually ensures taxpayers leverage this election for maximum benefit. Policies must be in place at the beginning of the tax year to qualify.
Materials and Supplies
Taxpayers can often deduct the cost of materials and supplies earlier for tax purposes than for book purposes. Categories include:
- Nonincidental Supplies: Deducted when consumed.
- Incidental Supplies: Deducted when purchased.
- Temporary Spare Parts: Deducted upon disposal.
By aligning these deductions with the de minimis safe harbor, taxpayers can accelerate tax benefits.
How Section 179 and Bonus Depreciation Work Together
When utilized together, Section 179 and bonus depreciation can provide the most significant advantages. Typically, IRS rules require businesses to apply Section 179 first, followed by bonus depreciation. This strategy guarantees taxpayers optimize immediate deductions while maintaining adaptability for higher-value acquisitions.
For example, in 2024:
- Equipment Cost: $3,000,000
- Section 179 Deduction: $1,220,000
- Bonus Depreciation Deduction: $1,068,000
- Standard First-Year Depreciation (assuming 5-year MACRS property): $142,400
- Total First-Year Deduction: $2,430,400
- Cash Savings on Purchase (21% C-Corp tax rate): $510,384
- Lowered Cost of Equipment After Tax Savings: $2,489,616
Procedural Considerations
Many adjustments to fixed-asset accounting methods require filing Form 3115, Application for Change in Accounting Method. Taxpayers should verify eligibility for automatic accounting method changes and meet applicable deadlines under IRS guidance.
Cost Segregation: A Continuing Opportunity
Cost segregation remains a vital tool for speeding up depreciation deductions, even as bonus depreciation phases out. By identifying assets eligible for shorter recovery periods, businesses can:
- Enhance cash flow.
- Offset the impact of reduced bonus depreciation.
- Explore complementary tax incentives, such as Section 179 expensing.
Strategic Tax Planning Recommendations
- Proactive Asset Reviews: Conduct thorough reviews of fixed-asset records to identify opportunities for reclassification and expense acceleration.
- Optimize Timing: Plan acquisitions and placed-in-service dates to maximize deductions under the current bonus depreciation rate.
- Leverage Expertise: Consult tax professionals to navigate complex rules and implement effective strategies.
- Look at Other Incentives: Check out deductions and credits. These include the Research and Development Tax Credit and energy-efficient property incentives.
The bonus depreciation phase-out marks an important moment in tax planning. Businesses must adopt a forward-looking approach to maintain tax efficiency. By reassessing fixed-asset strategies and leveraging tools like cost segregation, taxpayers can navigate this evolving landscape effectively.
For tailored guidance, consult Notion CFO & Advisors to ensure your business remains well-positioned amidst these changes.
