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