Bonus depreciation, covered under Section 168(k) of the tax code, is set to expire at a rate of 20% each year through Dec. 31, 2027. But 2022 was the final year of 100% bonus depreciation, adding a significant wrinkle to this year’s tax filing deadline.
The Tax Cuts and Jobs Act of 2017 overhauled the bonus depreciation rules. It allowed businesses to immediately write off 100% of qualified property acquired and placed in service after Sept. 27, 2017, and before Jan. 1, 2023.
Qualified property under bonus depreciation includes modified accelerated cost recovery system assets with a recovery period of 20 years or less, computer software covered under Section 167(f), listed property (over 50% business use cameras and vehicles), and costs of qualified film or television productions covered under Section 181. Bonus depreciation also was expanded to include used property (if it was new to the taxpayer), as well as qualified improvement property, to nonresidential real estate property.
QIP is an improvement of Section 1250 property for a nonresidential building already placed in service. It includes interior upgrades such as drywall, plumbing, and electrical fixtures. It specifically excludes improvements to enlarge the building, elevators or escalators, and exterior portions of the building.
Although 2022 is behind us, it’s not too late to do a cost segregation study, which is an IRS-approved method of properly identifying QIP that identifies the components of a building into shorter useful lives—typically five, seven, and 15 years. The proper identification of these shorter useful lives can result in significant tax savings via bonus depreciation.
Cost segregation studies can be completed on the eligible property before the due date of the taxpayer’s tax return, including extensions, through Oct. 15, 2023. They usually take 30 to 60 days, so there’s still time to take full advantage.
Advantages of bonus depreciation include an immediate first-year deduction on the purchase of qualified property and no annual dollar limit. It also can be used to offset other income or create a net operating loss.
Although bonus depreciation may seem like an automatic go-to strategy, there are times when it may not be advantageous: for example, with expiring carryforwards such as pre-TCJA net operating losses or charitable contributions. Taking bonus depreciation may negate the benefits of those expiring deduction carryforwards which may hold some value in and of themselves.
Maximize qualified business income deductions also may not be ideal for bonus depreciation. Because bonus depreciation decreases taxable income, it will decrease the QBI Section 199(a) deduction. This is one of the 23 TCJA provisions set to expire in 2025, so it might make more sense to maximize the benefit of that deduction instead of taking bonus depreciation.
There are times where it’s simply preferred to slow down depreciation for certain start-up businesses projecting small net income or losses during their initial years in business. Even though bonus depreciation can create a taxable loss or a net operating loss, it may make sense to spread out the depreciation over time to offset income in later years rather than generate a net operating loss that is subject to limitations under the law.
Whatever the circumstances may be, the taxpayer needs to actively elect out when not using bonus depreciation. The election needs to be attached as a statement to Form 4562, Depreciation and Amortization.
Although the future is uncertain regarding the remaining sunset provisions of the TCJA, what we do know is that bonus depreciation is slowly sunsetting as we speak. Given the current landscape, it’s imperative to engage in proactive tax planning to provide maximum long-term tax savings.
Written by Pam Mosiello. Originally published by Bloomberg Tax.
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