The IRS incentivizes business investment in fixed assets by allowing for deductions of large asset purchases and improvements in the year they go into service. Two of the main deductions allowable in the U.S. tax code for this purpose are Section 179 and bonus depreciation. Both deductions offer tax advantages and disadvantages so it’s important to understand your options before applying them to assets purchased in any given tax year.
First, let’s explore the key differences between Section 179 and bonus depreciation deductions.
While both deductions can be applied to most personal property assets like equipment, furniture and machinery, the major difference involves real estate. With real estate, Section 179 can only be used to deduct the purchase of assets that qualify as Section 179 real property. 179 real property includes non-residential roofs, HVACs, security and fire alarm systems. When applying Section 179, the assets must be used primarily for business purposes.
Bonus depreciation is allowed on farm buildings and land improvements, whereas Section 179 is not. Assets that have a useful life of one to 20 years are eligible for bonus depreciation These also include land improvements like swimming pools, fences, roads, driveways, paved parking areas and patios.
One other important distinction is that bonus depreciation needs to be applied to all assets within an asset class life, whereas Section 179 is more flexible and can be applied on an asset by asset basis. For example, if you take bonus depreciation on any 5-year asset, like those listed below, you have to take it on all 5-year assets in that tax year.
5-Year Property according to the IRS includes:
- Automobiles, taxis, buses, and trucks.
- Any qualified technological equipment.
- Office machinery (such as typewriters, calculators, and copiers).
- Any property used in research and experimentation.
- Breeding cattle and dairy cattle.
- Appliances, carpets, furniture, etc., used in a residential rental real estate activity.
- Certain geothermal, solar, and wind energy property.
- Any machinery equipment (other than any grain bin, cotton ginning asset, fence, or other land improvement) used in a farming business and placed in service after 2017, in tax years ending after 2017. The original use of the property must begin with you after 2017.
Annual Deduction Limits
The Section 179 deduction limit for tax year 2023 is $1,160,000 with an investment limit of $2,890,000. There also needs to be sufficient business income during the year you plan to take the deduction. (Don’t forget the owner’s W-2 wages can count towards business income.)
The bonus depreciation deduction limit for the 2023 tax year is 80% of the asset cost, down from 100% in 2022. Additionally, there is no business income limit, so you can use this deduction even if you plan to report a loss for the business.
Timeline for Deduction
Both of these deductions have to be used in the tax year when the asset is placed into service. Section 179 allows the most flexibility in deferring expenses to future tax years as you can choose the exact amount to apply for the first year, with the rest depreciated normally over the useful life defined by the IRS. Bonus depreciation has to be applied to all new assets that fall into the asset class life. For example, if you purchase equipment for $100,000, you have to take the $80,000 bonus depreciation on this equipment and any other 5 year useful life assets for the year. With Section 179, you can choose to apply any amount from $1-$100,000 as a Section 179 deduction for the year. This allows you to fill up certain tax brackets with income by applying a specific dollar amount of Section 179 deduction in the year the $100,000 asset was placed in service.
Exceptions for Listed Property
Listed property is defined as an asset that may be used up to 50% of the time for personal use. The remaining >50% of the time, the asset must be used for business reasons in order to be deductible. Section 179 and bonus depreciation deductions can be applied to listed property but with special considerations. For vehicles under 6,000 pounds in the tax year 2023, Section 179 allows for a maximum deduction of $12,200 and bonus depreciation allows for a maximum of $8,000, for a total maximum deduction on listed property of $20,200.
Should you use Section 179 or Bonus Depreciation or both?
First and foremost, business owners need to have sufficient income to utilize Section 179, if they do not, they should use the bonus depreciation deduction. Second, business owners should evaluate how much they spent in fixed asset additions to determine their total allowable deduction under each option. They might not be able to take Section 179 if they purchased too many fixed assets. Finally, taxpayers should consider the tax bracket they are in currently and the tax bracket they expect to grow into. Their tax rate will affect whether they benefit from accelerated or straight-line depreciation of assets.
Can you use both Section 179 and Bonus Depreciation?
Yes, you can, and when you are near the Section 179 deduction limits and have additional fixed assets that qualify for accelerated depreciation you could use both. The benefit is that you are able to use additional depreciation deductions beyond the Section 179 limits. Be sure you are adhering to state by state regulations. Many states decoupled from the IRS rules regarding these deductions. When you apply both deductions at the federal level, it could make it difficult to calculate the portion of federal depreciation that needs to be added back for state tax return purposes.
Let’s look at an example of Section 179 vs bonus depreciation.
|Client A in 2023
|Net Business Income
|Fixed Asset Investments
*80% of $400K
Now consider Client A’s fixed asset investments in two different states:
- Kansas: Under Kansas rules, if Client A decided to utilize bonus depreciation, they would still be able to utilize the $320,000 deduction.
- California: If Client A’s equipment was located in California, they would only be able to apply a $80,000 deduction, $400,000 spread out over 5 years. California does not conform with the federal treatment of bonus depreciation and does not allow accelerated bonus depreciation.
We most often see these two deductions applied for manufacturing and real estate companies, but have creatively applied them for many industries as well. Every state is different in how they treat bonus depreciation and Section 179 deductions. A CPA can help you decide the best route for your business and your tax return. We’d love to help, schedule an appointment with us today.