Business Depreciation Under the TCJA, Part 1: Bonus Depreciation

LFL Veritas Blog: Depreciation Under TCJA Part 1

 

Business Depreciation Under the TCJA, Part 1: Bonus Depreciation

The rules and limitations for two methods used by businesses for expensing fixed assets – bonus depreciation and Section 179 expensing – changed significantly when the Tax Cuts and Jobs Act (TCJA) of 2017 was passed. There are new provisions in the tax code that allow you to handle each method differently to maximize tax benefits.

The high-level takeaway is that businesses can immediately expense more under the new tax law. In Part 1, we’ll focus on changes to bonus depreciation rules and how these changes could affect small to midsize businesses.

What Is Bonus Depreciation?

Bonus depreciation, also called the additional first-year depreciation deduction, allows a business to immediately deduct a large percentage of the cost of a qualifying asset instead of simply writing it off over the course of that asset’s useful life. Bonus depreciation was introduced in 2002 as a way to stimulate the economy by enabling businesses to recover the cost of capital acquisitions more quickly.

Bonus Depreciation Rate Increases to 100 Percent for Qualified Assets

Back it 2002, bonus depreciation allowed companies to deduct 30 percent of the cost of qualified assets. In 2003, the rate was increased to 50 percent, but legislation in 2015 included a phase-out of bonus depreciation to 40 percent in 2018 and 30 percent in 2019.

However, the TCJA implemented a new 100 percent write-off for qualified property acquired and placed in service between September 28, 2017 and December 31, 2022. The period extends to 2023 for longer production property and certain aircraft.

The bonus depreciation rate will eventually be phased out as follows:

  • 80 percent in 2023
  • 60 percent in 2024
  • 40 percent in 2025
  • 20 percent in 2026
  • 0 percent after 2026

What Qualifies for Bonus Depreciation?

The qualified property or asset must be a MACRS (Modified Accelerated Cost Recovery System) property with a recovery period of 20 years or less, computer software, or water utility property. The TCJA also adds qualified film, television and live theatrical products as types of qualified property for 100 percent bonus depreciation.

The TCJA also expands the definition of property eligible for 100 percent business depreciation to include used property. According to the IRS, used qualified property acquired and placed in service after September 27, 2017 is eligible if:

  • The taxpayer didn’t use the property at any time before acquiring it.
  • The taxpayer didn’t acquire the property from a related party.
  • The taxpayer didn’t acquire the property from a component member of a controlled group of corporations.
  • The taxpayer’s basis of the used property is not figured in whole or in part by reference to the adjusted basis of the property in the hands of the seller or transferor.
  • The taxpayer’s basis of the used property is not figured under the provision for deciding basis of property acquired from a decedent.

Certain types of property don’t qualify for bonus depreciation under the new law, including assets used for the sale of electrical energy, water or sewage disposal services, or assets used for the sale of gas or steam through a local distribution system or via pipeline. Also, assets required to be depreciated under the alternative depreciation system are not eligible for bonus depreciation.

New Depreciation Limitations for Passenger Vehicles

For passenger vehicles placed in service after December 31, 2017, the depreciation deduction limits are as follows if bonus depreciation is not claimed:

  • $10,000 for the first year
  • $16,000 for the second year
  • $9,600 for the third year
  • $5,760 for each later taxable year in the recovery period

The depreciation deduction limits are as follows if 100 percent bonus depreciation is claimed:

  • $18,000 for the first year
  • $16,000 for the second year
  • $9,600 for the third year
  • $5,760 for each later taxable year in the recovery period

Recovery Period for Real Property

Qualified lease-hold improvement property, qualified restaurant property and qualified retail improvement property had been separately defined and afforded a reduced write-off of 15 years. Although their omission from the new tax law is more of a technical glitch than anything else, these assets now revert to previous recovery periods of 39 years for nonresidential real property and 27.5 years for residential rental property.

Also, the alternative depreciation system recovery period for residential rental property has been reduced from 40 years to 30 years. If you elect out of the interest deduction limit, you must use the alternative depreciation system to depreciate nonresidential real property, residential rental property, and qualified improvement property.

Because the recovery period is longer than 20 years, none of these properties qualify for bonus depreciation. These changes apply to property placed in service in 2018 or later.

Overall, these changes are very business-friendly and you have the opportunity to expense more of your assets. You just have to make sure your properties or assets qualify and understand how your state handles federal provisions of tax law. In the next post, we’ll discuss how Section 179 expensing has changed under the TCJA.

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