One of the more robust tax incentives over the past several years has been Bonus Depreciation. This tax provision allowed companies to accelerate depreciation on purchased equipment to the year it was purchased, and write the amount off on their taxes. This made it especially useful to construction companies who make large-ticket capital equipment purchases.
The Tax Cut and Jobs Act of 2017 expanded Bonus Depreciation to 100% of an item’s purchase price, and it has been at that level since. This means a company could depreciate and write off the entire cost of purchases in the year they were acquired (as opposed to taking smaller depreciation amounts each year). This had a marked effect on lowering the tax obligations of companies who purchased equipment.
However, written into that 2017 Act was a planned phase-out, which begins in 2023. Since minimizing taxes is high on any company’s wish list, those entities that relied on Bonus Depreciation to lower their taxes should be aware of the changes.
This article will review the basics of Bonus Depreciation, how it works, and the details of the Phase-out. It will also detail the differences between Bonus Depreciation and Section 179 (which are similar and often discussed together). Finally, we’ll discuss some strategies companies can utilize to soften the phase-out blow.
Bonus Depreciation In a Nutshell
Bonus Depreciation was introduced in 2002 to encourage businesses to self-invest by purchasing capital equipment.
The way it works is it allows companies to depreciate a large chunk of an item’s purchase price in year one. The way depreciation normally worked was to utilize the Modified Accelerated Cost Recovery System, or MACRS for short. The MACRS depreciation schedule is what the IRS uses, and it includes all categories of business equipment.
For example, on the MACRS table, trucks and heavy equipment typically carry a five-year schedule, so normal depreciation would be 20% yearly for five years.
Bonus Depreciation allows companies to claim a larger chunk of the depreciation the year it was purchased. Back in 2002 it was 50%, but as stated earlier, in 2017 was raised to 100%, where it has been since. This allowed companies to fully depreciate purchased assets immediately and write off the entire cost on their taxes. Subsequently, Bonus Depreciation has proven very popular with companies who purchase equipment.
But the program is beginning a phase-out. For 2023, first-year Bonus Depreciation is 80% of the purchase price. It falls to 60% in 2024, 40% in 2025, and 20% in 2026. In 2027, the program will cease to exist.
Please note that nothing is lost – 2023 has an 80% first-year depreciation, but that extra 20% is still claimed over the useful life.
Section 179 and Bonus Depreciation – Same But Different
Many people think Section 179 and Bonus Depreciation are the same thing (especially since they are often talked about together). While it’s true they are both accelerated depreciation schedules, there are several stark differences.
The Limits are Different
Section 179 has hard cap limits, both in the amount that can be written off and the total amount a company can spend on capital equipment.
For 2023, Section 179 has a deduction limit of $1.16 million. The “total equipment purchased” limit is $2.89 million. Once that spending limit is reached, the deduction reduces dollar-for-dollar until it disappears (so Section 179 disappears entirely once a company spends $4.050 million on equipment).
But there are no limits on Bonus Depreciation. A company may spend as much as they wish on equipment and use Bonus Depreciation on all of it. The two can also be used together. Companies can take the maximum Section 179 deduction and then use Bonus Depreciation on the rest.
Flexibility On Which Equipment to Include
Section 179 is very flexible and allows a company to cherry-pick which equipment purchases to claim.
Bonus Depreciation is more rigid. Remember the MACRS classification mentioned earlier? With Bonus Depreciation, if you utilize it on one item in a certain class, you must utilize it on all items of that class purchased that year.
To give a simple example, let’s say a company purchases five pieces of heavy equipment – two heavy duty work trucks, a backhoe, a dump truck, and a skid steer. With Section 179, they can claim as many or as few as they wish. If they wanted, they could claim three of them this year, and save the other two for yearly depreciation. But with Bonus Deprecation, that flexibility is not available – if they want to claim Bonus Depreciation on any one of them, they must claim all five (and any other equipment purchased that shares the same MACRS classification).
Revenue Differences
Only companies that show a profit can use Section 179. And further, using Section 179 cannot result in a loss.
There are no profit or loss restrictions on Bonus Depreciation – it may be used irrespective of profitability. Further, companies may use Bonus Depreciation to create a loss, which can be favorable in some circumstances.
Equipment Types
Both Section 179 and Bonus Depreciation can be used for almost any new or preowned equipment a company can purchase. Trucks, heavy equipment, machines, IT, office equipment, furniture, signage, and even most software.
But certain building improvements are also eligible for Section 179. These include security systems, fire suppression, HVAC, and similar. Bonus Depreciation cannot be used for these.
Who Is Affected by the Phase-out?
Any company that purchases equipment may be affected. It all depends on how they (or their accountants) plan to depreciate purchases. Indeed, many companies may not know exactly which depreciation schedule their accountants used – it’s important to find this out in 2023.
Spending may also come into play (remember Section 179’s limits). This makes the phaseout particularly impactful for companies who are planning a large equipment spend (note: I expect this article to result in a few phone calls to the company accountant – that’s good!)
Strategies for Affected Companies
While many companies are likely to be affected, there are a few strategies they can deploy to lessen the impact.
The first strategy is to accept the 80% cap, as it’s still a large number. In fact, if a company has plans for a large 2024 equipment spend (and was planning on using Bonus Depreciation), it might be advantageous to move those purchases to 2023, as 80% is better than 2024’s 60%.
Conversely, if a company’s equipment spend will be under Section 179’s limits, simply utilizing that deduction over Bonus Depreciation makes a lot of sense. And even if they exceed the limits, using the entire Section 179 deduction and then taking 80% on what’s left over can still result in a much lower tax bill.
Lastly, a company can look into leasing equipment instead of buying/owning it, especially in future years when the bonus depreciation gets closer to zero.
The 2023 Bonus Depreciation phaseout will affect construction companies relying on it for a tax deduction. But there are practical approaches companies can use to mitigate the smaller percentages. Whether it's acting sooner on future purchases to take advantage of 2023's 80% rate, or turning to Section 179 instead, companies should be aware of Bonus Depreciation's phaseout and utilize all tax deductions available to them.
