Even before passage of the Tax Cuts and Jobs Act (TCJA), construction companies and other types of businesses were eligible for several generous depreciation-based tax breaks. Now it’s a veritable tax bonanza! If you take advantage of one or a combination of the following four provisions, you may be able to depreciate all or most of the cost of business property the first year it’s placed in service.
1. Section 179 Expensing
Under Section 179 of the Internal Revenue Code, a business can elect to “expense” (currently deduct) the cost of qualified property placed in service, up to an annual limit. However, the deduction can’t exceed the amount of income from the business activity and it’s subject to a phaseout above a specified threshold.
Before recent tax reform, the maximum Sec. 179 deduction only gradually increased to $500,000, and the phaseout threshold peaked at $2 million. The TCJA has effectively doubled the maximum deduction to $1 million and increased the phaseout threshold to $2.5 million, with inflation indexing.
So, if your construction business has 2019 earnings of $5 million and it buys $1 million of equipment, it can write off the entire cost this year. It’s important to note, however, that some businesses will be affected by the taxable income limit.
2. Bonus Depreciation
Thanks to another TCJA provision, the 50% bonus depreciation deduction has doubled to 100%. It’s effective for qualified property placed in service after September 27, 2017.
For bonus depreciation purposes, qualified property includes tangible property depreciable under the Modified Accelerated Cost Recovery System (MACRS) with a recovery period of 20 years or less. Significantly, the TCJA has also expanded the definition of qualified property to include used property. Previously, only new property was eligible.
By combining Sec. 179 deduction and bonus depreciation, you may be able to write off the full cost of depreciable business property the first year you place it in service. But be aware that the bonus depreciation deduction will be phased out after five years as follows:
- 80% for property placed in service in 2023,
- 60% for property placed in service in 2024,
- 40% for property placed in service in 2025, and
- 20% for property placed in service in 2026.
After 2026, bonus depreciation will no longer be allowed (unless, of course, new tax legislation extends it).
3. MACRS Deductions
MACRS is the method most often associated with standard depreciation deductions. Under this method, the cost of qualified property placed in service is recovered over a period of years. The system is designed to provide bigger write-offs in the early years of ownership.
Annual deductions are based on the useful life of the property. For example, computers have a five-year write-off period, while most other equipment is depreciated over seven or 15 years. Typically, a construction business may use Sec. 179 and bonus depreciation deductions with MACRS deductions for any remainder.
4. Business Vehicle Write-offs
The TCJA has also enhanced write-offs for business vehicles. According to the special rules for “luxury automobiles,” depreciation deductions are subject to annual limits. Previously, these limits kicked in at relatively low levels. But vehicles placed in service after 2018 can benefit from increased dollar limits that are indexed for inflation. Now, the annual deduction limits for a passenger car or light duty truck or van are:
- $10,000 for the first year placed in service,
- $16,000 for the second year,
- $9,600 for the third year, and
- $5,760 for each succeeding year.
The TCJA retained the $8,000 additional first-year depreciation break for passenger vehicles. Therefore, you should be able to deduct up to $18,000 the first year you place a vehicle in service.
Watch Out for the Last-Quarter Tax Tap
Despite enhancements to Section 179 and bonus depreciation, you may decide to use the Modified Accelerated Cost Recovery System (MACRS) to recover the cost of business property over time. If so, beware of a little-known tax trap.
Typically, MACRS deductions are calculated under a “mid-year convention.” This means that you benefit from a half-year’s deduction, regardless of when during the year you placed the property in service. However, if property placed in service in the year’s last quarter — October 1 through December 31 — exceeds 40% of the cost of all assets placed in service during the year, depreciation deductions for all property are figured under the “mid-quarter convention.” This generally reduces depreciation deductions for the year.
Boon for Business
TCJA’s depreciation-related breaks are widely recognized as a boon for businesses. As you contemplate making year-end purchases, be sure to factor in potential tax advantages.