Many manufacturers are eligible for tax write-offs for certain equipment purchases and building improvements. These writeoffs can do wonders for a manufacturer’ s cash flow, but whether to claim them isn’ t always an easy decision. In some cases, there are advantages to the regular depreciation rules. So it’ s critical to look at the big picture and develop a strategy that aligns with your company’ s overall taxplanning objectives.
MANUFACTURERS BEWARE:
First-Year Bonus Depreciation and Section 179 Expensing Pitfalls
Many manufacturers are eligible for tax write-offs for certain equipment purchases and building improvements. These writeoffs can do wonders for a manufacturer’ s cash flow, but whether to claim them isn’ t always an easy decision. In some cases, there are advantages to the regular depreciation rules. So it’ s critical to look at the big picture and develop a strategy that aligns with your company’ s overall taxplanning objectives.
BACKGROUND Taxpayers can elect to use the 100 % bonus depreciation or the Section 179 expensing election to deduct the full cost of eligible property up front, in the year it’ s placed in service. Alternatively, they may spread depreciation deductions over several years or decades, depending on how the asset is classified under the tax code. Note that 100 % bonus depreciation is available for property placed in service through 2022. Then, allowable bonus depreciation will be phased down to 80 % for property placed in service in 2023, 60 % in 2024, 40 % in 2025, and 20 % in 2026. After 2026, bonus depreciation will no longer be available.
In March 2020, a technical correction made by the Coronavirus Aid, Relief, and Economic Security( CARES) Act expanded the reach of bonus depreciation. Under the act, qualified improvement property( QIP), which includes many interior improvements to commercial buildings, is eligible for 100 % bonus depreciation retroactively to 2018. So, taxpayers that placed QIP in service in 2018 and 2019 may have an opportunity to claim bonus depreciation by amending their returns for those years. If bonus depreciation isn’ t claimed, QIP is generally depreciable on a straight-line basis over 15 years.
Section 179 also allows taxpayers to fully deduct the cost of eligible property, but the maximum deduction in a given year is $ 1 million( adjusted for inflation), and the deduction is gradually phased out once a taxpayer’ s qualifying expenditures exceed $ 2.5 million( also adjusted for inflation).
EXAMPLES While 100 % first-year bonus depreciation or Section 179 expensing can significantly lower your company’ s taxable income, it’ s not always a smart move. Here are three examples of situations where it may be preferable to forgo bonus depreciation or Section 179 expensing:
1. You’ re planning to sell QIP. If you’ ve invested heavily in building improvements eligible for bonus depreciation as QIP, you may be stepping into a tax trap by writing it off if you plan to sell the building in the near future. That’ s because your gain on the sale— up to the amount of bonus depreciation or Section 179 deductions you’ ve claimed— will be treated as“ recaptured” depreciation that’ s taxable at ordinary-income tax rates as high as 37 %. On the other hand, if you deduct the cost of QIP under regular depreciation rules( generally, over 15 years), any long-term gain attributable to those deductions will be taxable at a top rate of 25 % if
6 VIEWpoint Issue 2 | 2021