Section 179 Expensing vs. Bonus Depreciation – The Basics

Whether it’s a forklift or a new building, certain assets can help generate revenue for multiple years. In an effort to better match the cost of these assets with the revenue they generate, the purchases are expensed over multiple tax years in a process called “depreciation.”

The IRS has provided two incentives to purchase assets like these. “Section 179 Expensing” and “Bonus Depreciation” allow businesses to circumvent a longer depreciation expense write-off period by deducting the full cost of an asset in the year it is placed in service.

However, how are we to know which incentive to use? Read on for an answer.

Section 179 Expensing

Section 179 allows a taxpayer to deduct the full cost of a qualified asset in the year it is placed in service. While Section 179 has many restrictions, these three are especially relevant when also looking at bonus depreciation:

• A taxpayer can only use Section 179 on up to $1.04 million of qualifying property. This limit begins to get even lower if the taxpayer places more than $2.59 million of qualifying property into service.
• Any Section 179 expense is limited to the amount of one’s net business income. In the case of a loss, any Section 179 taken will be deferred until a year in which income exists.
• Most assets that are eligible for Section 179 will also be eligible for bonus depreciation. However, certain assets like HVAC systems, roofs and alarm systems are exclusive to section 179 when they are placed into service in a nonresidential context.

While Section 179 can often seem complex, the general rule is this: if you are placing into service eligible assets costing an amount that is less than your taxable income, you can use Section 179.

Bonus Depreciation

For assets placed in service after December 31, 2017, and before December 31, 2022, bonus depreciation may also be used to offset 100% of an eligible asset’s cost. Under current law, this percentage will begin to decrease 20 percentage points each year, starting in 2023 until reaching 0% in 2027.

Here are some ways in which bonus depreciation differs from Section 179:

• There is no limit based on how much qualifying property has been placed in service.
• There is no taxable income limitation. Bonus depreciation can reduce income, create a loss or increase an existing loss.
• While Section 179 can be taken on an asset-by-asset basis, bonus depreciation must be taken on an entire class of assets.

Tax Planning – Comparison

We now have two key observations: (I) both bonus depreciation and Section 179 allow us to circumvent a longer depreciation write-off period and (II) bonus depreciation allows us to bypass many of section 179’s limitations. With these in mind, when do we use each?

In many cases, bonus depreciation is easier to use than section 179. However, there are a few situations where Section 179 should be strongly considered:

• If a certain level of taxable income is desired, Section 179 will often be the better choice because the taxpayer can select specific assets to expense. On the other hand, bonus depreciation is less flexible because it operates on asset class lives (i.e., 5-year property, 15-year property, etc.) This means all assets placed into service during the year with the same class life must be expensed under bonus depreciation.
• By taking Section 179 or not in a year in which you have a loss, you can possibly defer depreciation expense until a year you have income. If you expect to be in a higher tax bracket in the future, deferring the expense until then may provide more tax savings.
• State nonconformity issues may apply. For example, Minnesota has conformed to Section 179 but not to bonus depreciation. In cases like this, Section 179 may be used to avoid increasing your state-level income.

Conclusion

Bonus depreciation and Section 179 expensing are often rife with confusion due to their similarity. Knowing when to use each is a great tool to have in your toolbox, especially when doing tax planning.

If you have additional questions, please reach out to Tyler Sauve , CPA or contact our Tax Solutions team at Mahoney to be of help to you in any way.