Editors: Brian Hagene, CPA, CGMA, and Mark G. Cook, CPA, CGMA
Sec. 179 expensing and bonus depreciation provide significant tax savings opportunities for taxpayers but require a thorough understanding of the tax law differences between the deductions as well as thoughtful analysis and comparisons to maximize those savings. Sec. 179 expensing was not used as frequently in recent years as previously because many taxpayers have relied on 100% bonus depreciation. Bonus depreciation is phasing out and will require practitioners to take a closer look at Sec. 179 expensing as a tax saving strategy.
Bonus depreciation
The opportunity to take advantage of 100% bonus depreciation, which was enacted in 2017 under the Tax Cuts and Jobs Act, P.L. 115-97, expired for property placed in service after Dec. 31, 2022. Bonus depreciation for assets placed in service (other than longer-production- period property) during 2024 is 60% of the purchase price of the asset and will be 40% for assets placed in service in 2025. The percentage will continue phasing out in future years and will be fully phased out for property placed in service after Dec. 31, 2026.
In the next few years, assets placed in service will be subject to a combination of bonus and modified accelerated cost recovery system (MACRS) depreciation. Therefore, practitioners should devote more attention to making sure assets are assigned accurate class lives to maximize the MACRS portion of the depreciation deduction. Cost segregation studies will remain important and provide support in the event of an IRS audit for the assignment of shorter and accurate MACRS class lives for building components.
Planning opportunity: Sec. 168(e)(6) defines qualified improvement property (QIP) as improvements that are made by the taxpayer to the interior portion of a building that is nonresidential real property.
The improvement needs to be placed in service after the date the building was first placed in service. Expenditures related to the enlargement of the building, elevators, escalators, or the internal structural framework of the building are excluded from the definition of QIP.
QIP qualifies for both bonus depreciation and Sec. 179 expensing. Land improvements qualify for bonus depreciation but not Sec. 179 expensing. Sec. 179 provides flexibility because it can be applied on an asset-by-asset basis. Practitioners should use the maximum permitted Sec. 179 expensing on QIP if the taxpayer has purchased assets that exceed the maximum Sec. 179 expense deduction for the tax year or if they are subject to one of the other Sec. 179 expensing limitations addressed later in this item. Any remaining QIP will qualify for bonus depreciation. Using Sec. 179 expensing on assets with longer lives, such as QIP, will maximize current tax savings by preserving assets with shorter lives for bonus and MACRS depreciation. Sec. 179 deductions claimed on QIP are subject to ordinary-income recapture rules under Sec. 1245 and do not qualify for Sec. 1250 recapture when the assets are sold.
Bonus depreciation deducted on QIP may also be subject to ordinary-income recapture under Sec. 1245 when the asset is sold. QIP is 15-year property subject to straight-line depreciation. Regs. Secs. 1.1250-1(a)(1)(i) and 1.1250-2 require taxpayers to report ordinary-income recapture to the extent that bonus depreciation and accelerated depreciation exceed straight-line depreciation, as shown in the table “Depreciation Recapture on the Sale of QIP.”
Planning opportunity: Bonus depreciation needs to be applied to all assets within an asset class life. Practitioners may take advantage of this rule when a taxpayer has excess business losses that would not be deductible under Sec. 461(l). Excess business losses under Sec. 461(l) are carried forward as a net operating loss (NOL). The NOL generated by Sec. 461(l) losses is generally deductible against up to 80% of taxable income in future years. With proper planning, however, an NOL subject to Sec. 461(l) limitations may be avoided. For example, the taxpayer could elect out of bonus depreciation on select classes of assets to limit the depreciation expense deduction without exceeding the Sec. 461(l) loss limitation for the tax year.
Sec. 179 expense
The 2024 maximum Sec. 179 expense deduction is $1,220,000. The Sec. 179 expense deduction is phased out if qualifying purchases exceed $3,050,000 during the tax year. The 2025 Sec. 179 limits are adjusted for inflation.
Planning opportunity: Secs. 179(d)(1)(B)(ii) and (e) permit taxpayers to expense in the year of purchase costs for qualified real property. Qualified real property includes QIP and certain improvements to nonresidential buildings placed in service after the building was first placed in service and includes roofs, heating and ventilation systems, air conditioning units, fire protection and alarm systems, and building security systems. Sec. 179 deductions claimed on qualified real property are subject to ordinary-income recapture rules upon sale under Sec. 1245.
Unlike bonus depreciation, Sec. 179 expensing cannot be used to create a loss. Taxpayers cannot deduct Sec. 179 expense in excess of their business income limitation (Sec. 179(b)(3)). There are several adjustments to taxable income to determine the business income limitation for an entity, including the addback of Sec. 179 expense, deductions for partner guaranteed payments, deductions for compensation paid to S corporation shareholders, and C corporation NOLs. Individual taxpayers calculate their business income limitation by adding back Sec. 179 expense, the deduction for one-half of self-employment tax under Sec. 164(f), and NOL deductions. Additionally, individual taxpayers can include all wages and tips earned as an employee in determining their business income limitation.
Taxpayers are permitted to carry forward excess Sec. 179 expense. This may be a beneficial option for taxpayers if they are confident that they will be able to use the entire carryover in the next few years.
As shown in the table “Planning Opportunity for Sec. 179,” the taxpayer can deduct 71.2% of the cost of the equipment by the end of the second year under the bonus depreciation rules. Therefore, taking Sec. 179 expensing on 100% of the property cost and carrying over any excess to future years is a recommended strategy if the taxpayer expects sufficient income to absorb the carryover in the next few years.
Trust planning opportunity: Sec. 179(d)(4) provides that trusts (other than grantor trusts) and estates are not permitted to deduct Sec. 179 expense. Regs. Sec. 1.179-1(f ) (3) provides that a partner or S corporation shareholder that is a trust or estate shall not deduct its allocable share of the entity’s Sec. 179 expense that would otherwise have been allocated to it. The entity may claim a depreciation deduction under Sec. 168 (including bonus depreciation, if applicable) for the depreciable basis that is a result of the trust or estate’s inability to claim its portion of the Sec. 179 expense. If the depreciable property is expected to be held short term, then the higher property basis will result in a lower gain when the property is eventually sold. Alternatively, if the property is expected to be held long term, the taxpayer can use bonus depreciation rather than Sec. 179 on qualifying assets, which may result in a more rapid deduction of the asset cost.
Observations regarding lessors: Sec. 179(d)(5) provides that Sec. 179 expensing is not available to noncorporate lessors unless:
- The property subject to the lease has been manufactured or produced by the lessor, or
- The term of the lease (taking into account options to renew) is less than 50% of the class life of the property (as defined in Sec. 168(i)(1)), and for the first 12 months after the date the property is transferred to the lessee, the sum of the Sec. 162 deductions, other than rents and reimbursed amounts with respect to such property, allowable to the lessor exceeds 15% of the rental income produced by the property.
The provisions of Sec. 179(d)(5) are often difficult for taxpayers to meet. Most taxpayers do not manufacture or produce rental property. Additionally, Sec. 162 expenses do not include interest, taxes, and depreciation expense. In many situations, the remainder of the rental expenses do not exceed 15% of the rent income. Therefore, bonus depreciation will often provide a more favorable tax result in these circumstances.
Another important provision, Sec. 179(d)(6), states that all members of a controlled group shall be treated as one taxpayer. In defining a “controlled group,” Sec. 179(d)(7) refers to Sec. 1563(a). However, Sec. 179(d)(7) provides that the 80% test in Sec. 1563(a) be replaced with a 50% test for voting power and value of stock shares in a parent-subsidiary structure for purposes of determining if the definition of a “controlled group” is met.
Practitioners should carefully evaluate commonly owned entities to determine if the controlled-group provisions apply before finalizing tax returns and deducting Sec. 179 expense. If the entities meet the definition of a controlled group, then the practitioner should evaluate the assets of all entities simultaneously and carefully choose which assets to take Sec. 179 expensing on to maximize the group’s overall tax savings.
Comparing tax savings
As bonus depreciation continues to phase out, Sec. 179 expensing will play a more significant role in maximizing deductions for fixed-asset purchases. It will be important for practitioners to understand the differences between the rules for bonus depreciation and Sec. 179 expensing to avoid tax return errors and maximize tax savings. Practitioners will also need to analyze and compare the tax savings between bonus depreciation vs. Sec. 179 expensing deductions to determine the best outcome for taxpayers.
Editor Notes
Brian Hagene, CPA, CGMA, is partner/owner at Mathieson, Moyski, Austin & Co. LLP in Lisle, Ill., with CPAmerica. Mark G. Cook, CPA, CGMA, MBA, is the lead tax partner with SingerLewak LLP in Irvine, Calif.
For additional information about these items, contact [email protected].
Contributors are members of or associated with CPAmerica or SingerLewak LLP.
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