14 Nov 2022 Tax Planning: Bonus Depreciation
For assets with a useful life of more than one year, you generally must depreciate the cost over a period of years. In most cases the Modified Accelerated Cost Recovery System (MACRS) will be preferable to the straight-line method because you’ll get a larger deduction in the early years of an asset’s life.
But if you make more than 40% of the year’s asset purchases in the last quarter, you could be subject to the less favorable mid-quarter convention. When it comes to repairs and maintenance of tangible property, however, different rules may apply. Careful planning during the year can help you maximize depreciation deductions in the year of purchase.
Other depreciation-related breaks and strategies also are available, and in many cases have been enhanced by the Tax Cuts and Jobs Act (TCJA):
This additional first-year depreciation is available for qualified assets, which include tangible property with a recovery period of 20 years or less (such as office furniture and equipment), off-the-shelf computer software and water utility property.
Under the TCJA, through 2026, the definition has been expanded to include used property and qualified film, television and live theatrical productions. In addition, qualified improvement property is now eligible for bonus depreciation.
For qualified assets placed in service though Dec. 31, 2022, bonus depreciation is 100%. In later years, bonus depreciation is scheduled to be reduced as follows:
80% for 2023
60% for 2024
40% for 2025
20% for 2026
For certain property with longer production periods, these reductions are delayed by one year. For example, 80% bonus depreciation will apply to long-production-period property placed in service in 2024.
Warning: Under the TCJA, in some cases a business may not be eligible for bonus depreciation starting in 2018. Examples include real estate businesses that elect to deduct 100% of their business interest expense and dealerships with floor-plan financing, if they have average annual gross receipts of more than $25 million for the three previous tax years.
Section 179 expensing election. This allows you to deduct (rather than depreciate over a number of years) the cost of purchasing eligible new or used assets, such as equipment, furniture, off-the-shelf computer software, and qualified improvement property. For qualifying property placed in service in 2022, the expensing limit is $1.08 million (up from $1.05 million for 2021). The break begins to phase out dollar for dollar when asset acquisitions for the year exceed $2.7 million (up from $2.62 million for 2021). You can claim the election only to offset net income, not to reduce it below zero to create a net operating loss.
Tangible property repair safe harbors. A business that has made repairs to tangible property, such as buildings, machinery, equipment and vehicles, can expense those costs and take an immediate deduction. But costs incurred to acquire, produce or improve tangible property must be depreciated. Distinguishing between repairs and improvements can be difficult. Fortunately, some IRS safe harbors can help: 1) the routine maintenance safe harbor, 2) the small business safe harbor, or 3) the de minimis safe harbor. The rules are complex, so contact your tax advisor for details.
Cost segregation study. If you’ve recently purchased or built a building or are remodeling existing space, consider a cost segregation study. It identifies property components and related costs that can be depreciated much faster and dramatically increase your current deductions. Typical assets that qualify include decorative fixtures, security equipment, parking lots, landscaping and architectural fees allocated to qualifying property. See the Case Study “Cost segregation study can accelerate depreciation.”
The benefit of a cost segregation study may be limited in certain circumstances — for example, if the business is located in a state that doesn’t follow federal depreciation rules.
How businesses can maximize their tax savings
This year some businesses are thriving while others are still struggling to recover from the pandemic and resulting economic crisis. Whatever your business’s situation, taking full advantage of available tax breaks is critical. Changes under the TCJA still demand attention.
If you own the business, it’s likely your biggest investment, so thinking about long-term considerations, such as your exit strategy, is critical as well. And if you’re an executive, you likely have to think about not only the company’s taxes, but also tax considerations related to compensation you receive beyond salary and bonuses, such as stock options. Planning for executive comp involves not only a variety of special rules but also several types of taxes — including ordinary income taxes, capital gains taxes, the NIIT and employment taxes. The TCJA also provides a bit of potential tax relief for certain types of executive comp. View Business & Exec Comp Tax Planning Guide
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