Inflation and rising interest rates are affecting the spending plans of many businesses. But, if you’re contemplating a fixed asset purchase, you might want to pull the trigger before year-end. Doing so can help you make the most out of the lucrative tax break known as bonus depreciation.

The Basics

Bonus depreciation refers to the additional first-year depreciation deduction allowed under Section 168(k) of the tax code. Without bonus depreciation, businesses generally depreciate fixed assets over the course of their useful lives.

With bonus depreciation, you can accelerate the depreciation deduction. The total amount depreciated over the life of the asset doesn’t change, but you can significantly reduce your tax bill in the year you purchase eligible property and place it in service for your business — in turn improving your cash flow. Importantly, bonus depreciation isn’t subject to any limits or income-based phaseouts.

Eligible property includes computer systems, software, certain vehicles, machinery, equipment and office furniture — essentially, most property with a useful life of 20 years or less. In 2020, the CARES Act clarified that qualified improvement property (generally, interior improvements to nonresidential real property) also qualifies for bonus deprecation. (If you placed qualified improvement property in service in 2018 through 2021 without claiming bonus depreciation, you can claim a tax refund.)

Under the Tax Cuts and Jobs Act (TCJA), the deduction is available for both new and used property. The latter is eligible as long as it wasn’t:

• Used by the taxpayer or a predecessor any time before acquiring it,
• Acquired from a related party, or
• Acquired as part of a tax-free transaction.

The IRS will automatically apply bonus depreciation to eligible property unless you choose to elect out. In that case, the election will apply to all qualified property in that same class of property (for example, all seven-year MACRS property) that’s placed in service during the applicable taxable year.

Important: Don’t confuse the bonus depreciation program with Section 179 deductions. Although these tax breaks are similar, Sec. 179, which is geared toward smaller businesses, is subject to certain limits that don’t apply to bonus depreciation. Specifically, for 2022, the maximum allowable Sec. 179 deduction is $1.08 million, and the deduction is reduced, dollar-for-dollar, for amounts of aggregate qualifying purchases above $2.7 million.

Sense of Urgency

The TCJA increased bonus depreciation from its previous rate of 50% of the cost of eligible property to 100%. But the increase isn’t permanent.

The amount of the deduction will drop by 20% every year, as follows:

• 80% for property placed in service in calendar-year 2023,
• 60% for property placed in service in calendar-year 2024,
• 40% for property placed in service in calendar-year 2025, and
• 20% for property placed in service in calendar-year 2026.

For property with longer production periods and certain aircraft, these percentage cutbacks are delayed by one year. For example, the 80% deduction rate will apply to such property that is placed in service in 2024. Unless Congress takes action, the bonus depreciation program will expire in 2027 (or 2028 for assets with longer production periods and certain aircraft).

If you hope to take advantage of the full 100% deduction for 2022, you should act soon. The “placed in service” requirement is critical — you can’t claim the deduction for 2022 unless the property is placed in service on or before December 31, 2022. And, with the current labor and materials shortages compounded by shipping delays, it can be difficult to predict with certainty when your orders will arrive.

A Note of Caution

It may seem obvious that the best course of action is to maximize the bonus depreciation deduction by claiming it for 2022. But you may have good reason to take a different approach.

For example, the value of other tax breaks, such as net operating loss carryforwards and the qualified business income deduction, varies depending on your taxable income, and accelerating depreciation into 2022 could diminish that value by reducing your taxable income. In addition, the value of a deduction stems from how much it can cut your taxes for the year, meaning a deduction is more valuable when you’re in a higher tax bracket. So, if you expect to earn a substantially higher income or for tax rates to increase in the near future, the depreciation deduction might be worth more later.

Act Now

We can help you determine the best strategy to leverage the bonus depreciation deduction to minimize your taxes. Contact our tax specialists now so you have time to take the necessary steps.