When businesses invest in assets such as property, plant, and equipment, they cannot deduct the full cost in the year of purchase. The Internal Revenue Service (IRS) requires that the cost of such assets is spread over several years through a process called depreciation.
However, to encourage investment and stimulate economic growth, the government has introduced tax incentives such as Bonus Depreciation and Section 179. In this article, we will take a closer look at Bonus Depreciation and Section 179, how they work, their benefits, and recent changes to the rules.
We hope that by the end of this article, you will have a better understanding of how these tax incentives work and how to take advantage of them to grow your business.
Definition of Bonus Depreciation
Bonus depreciation is a tax incentive introduced in 2001 by the Economic Growth and Tax Relief Reconciliation Act (EGTRRA). It allows businesses to deduct a percentage of the cost of qualified property in the year they place it into service.
Bonus depreciation is intended to encourage businesses, especially small businesses, to invest in assets and stimulate the economy. The bonus depreciation rate has changed over the years.
Initially, it was 30%. However, the Tax Cuts and Jobs Act (TCJA) of 2017 increased the rate to 100% for qualified property placed in service between September 27, 2017, and December 31, 2022.
The 100% bonus depreciation rate is a significant increase and is expected to provide a considerable tax incentive for businesses to invest in property, plant, and equipment.
Definition of Section 179
Section 179 is an IRS tax code that allows businesses to deduct the full cost of qualified equipment or software purchased or leased during the tax year. The purpose of Section 179 is to encourage small businesses to invest in equipment and technology that will help them grow.
Unlike Bonus Depreciation, which applies to all eligible property and without a dollar limit, Section 179 only applies to qualified property up to a certain dollar amount. In 2021, the maximum amount of the deduction for Section 179 is $1.05 million.
Purpose and Benefits of Bonus Depreciation
The primary purpose of bonus depreciation is to encourage businesses to invest in qualified property and stimulate the economy. When businesses invest in property, plant and equipment, they create jobs, boost productivity, and improve the overall economy.
Bonus depreciation helps businesses reduce their tax liability, freeing up capital to invest in growth initiatives. Aside from the economic benefits, bonus depreciation has other significant advantages for businesses.
For instance, by claiming bonus depreciation, businesses can reduce their taxable income, allowing them to keep more of their earnings. Also, businesses can recover the cost of assets more quickly, allowing them to reinvest capital in other areas of the business.
Calculation of Bonus Depreciation
Bonus depreciation is calculated as a percentage of the cost of the qualified property. The following formula is used to calculate the deduction:
Deduction = Bonus depreciation rate cost basis
The cost basis is the amount paid for the qualified property, including any improvements and incidental expenses such as installation fees, delivery fees, and sales tax.
Changes to Bonus Depreciation Rules
The rules for bonus depreciation have changed over the years, with significant changes being introduced by the TCJA of 2017. Under the new rules, businesses can claim 100% bonus depreciation for qualified property placed in service between September 27, 2017, and December 31, 2022.
After that, the bonus depreciation rate will gradually decrease until it is phased out. The TCJA also expanded the definition of qualified property to include used property, computer software, and qualified film, television, and live theatrical productions.
Additionally, the TCJA introduced changes to how businesses account for depreciation and the use of like-kind exchanges.
Conclusion
Tax incentives such as bonus depreciation and Section 179 are vital tools for businesses looking to grow and invest in their futures. These incentives provide significant tax savings, reduce taxable income, and free up capital for businesses to reinvest in other areas.
By understanding how these incentives work and taking advantage of them, businesses can make smarter investments and drive growth.
Section 179
Purpose and Benefits of Section 179
One of the primary purposes of Section 179 is to provide an incentive for small businesses to invest in new equipment. By allowing businesses to deduct the cost of such equipment immediately, Section 179 aims to free up capital and encourage investment in growth initiatives.
One of the significant benefits of Section 179 is that it can help businesses save on taxes and reduce taxable income. Businesses can use the deduction to offset taxable income, reducing the amount of tax they owe.
Additionally, because the deduction is taken in the first year, businesses can recover the cost of the equipment more quickly, allowing them to focus on other areas of the business.
Qualifying Assets for Section 179
To qualify for a Section 179 deduction, businesses must have purchased or leased equipment, vehicles, or software that is used primarily for business purposes. Some examples of qualifying assets include computers, furniture, printing presses, and manufacturing equipment.
Vehicles such as trucks and vans can also qualify for the deduction, provided they are primarily used for business purposes. Additionally, the equipment or software must be new, meaning that it has not been previously used by another party.
If the equipment or software has been used before, it may still qualify for depreciation deductions but not for a Section 179 deduction.
Limitations of Section 179
While Section 179 provides an excellent tax incentive for businesses, it also has some limitations. For example, there is a maximum deduction limit each year, which is adjusted for inflation annually.
In 2021, the maximum deduction limit is $1.05 million, with a dollar-for-dollar phase-out beginning at $2.62 million. Additionally, the deduction is limited to the value of the property purchased.
For instance, if a business purchases a piece of equipment for $800,000, they can only deduct up to $800,000 under Section 179, even if the maximum deduction limit for the year is higher.
Similarities and Differences
Similarities between Bonus Depreciation and Section 179
One significant similarity between Bonus Depreciation and Section 179 is that they both provide tax deductions for asset depreciation. Both incentives allow businesses to reduce their taxable income by deducting the cost of qualifying assets.
Additionally, both Bonus Depreciation and Section 179 require Form 4562 to be filed with a business’s tax return. The form helps to identify the qualifying assets and calculate the deduction amount.
Finally, both incentives are applicable in the first year that qualifying assets are placed into service and help businesses recover the cost of assets more quickly.
Differences between Bonus Depreciation and Section 179
While both Bonus Depreciation and Section 179 offer tax incentives for businesses, there are also significant differences between the two. The first major difference is the type of deduction available.
Bonus Depreciation provides a percentage deduction of the cost of qualifying property, while Section 179 provides an upfront deduction of the entire cost. The annual limit of deduction is another significant difference between the two incentives.
Section 179 has an annual deduction limit of $1.05 million, while Bonus Depreciation has no limit. Additionally, the maximum amount of purchases that can be written off under Section 179 is $2.62 million; anything above this limit is subject to a phase-out of the deduction.
In contrast, there is no phase-out for Bonus Depreciation. Moreover, the statutory end date is different and an important consideration.
Section 179 has a permanent extension, which means that it is an ongoing tax incentive. Contrarily, Bonus Depreciation has a statutory end date, which is December 31, 2022.
The deduction rate will gradually decrease over time and will eventually be phased out completely. Profitability is another significant difference between the two incentives.
Bonus Depreciation can be used to create a net operating loss and to offset business income, including wages from employees. On the other hand, Section 179 can only be used to offset business income.
Finally, a notable difference between the two incentives is the improvement to real estate coverage. Bonus Depreciation can be used for qualified improvement property, meaning that it can be used for costs incurred to improve property inside a building, such as adding security equipment or upgrading lighting.
However, Section 179 cannot be used for these types of improvements.
Conclusion:
In conclusion, understanding the differences and similarities between Bonus Depreciation and Section 179 is crucial for businesses to make informed decisions when it comes to investing in assets and reducing their tax liability. While both incentives are valuable, businesses must evaluate their unique circumstances to determine which option will provide the most significant tax savings and help to grow their business in the long term.
Conclusion and
FAQs
Comparison of Bonus Depreciation and Section 179
While both Bonus Depreciation and Section 179 allow businesses to reduce their taxes by depreciating assets, they offer different incentives that businesses can use to their advantage. Bonus Depreciation provides a percentage-based deduction on qualified assets, while Section 179 allows immediate upfront deductions up to a certain dollar limit.
One potential strategy for businesses is to utilize both incentives together to maximize tax savings. Specifically, businesses can take advantage of the immediate upfront deduction by using Section 179 and then take advantage of accelerated depreciation through Bonus Depreciation.
Other factors to consider when choosing between Bonus Depreciation and Section 179 include the type of deduction, the annual limit of deduction, the maximum amount of purchases, the statutory end date, profitability, and comparison to business income, among others. Ultimately, businesses should evaluate their unique circumstances carefully and seek professional advice to determine which option will provide the most significant tax savings and help them grow their business.
FAQs
1. Can I take both Bonus Depreciation and Section 179 deductions on the same asset?
Yes, businesses can use both incentives on the same asset. In such cases, the Section 179 deduction is taken first, followed by Bonus Depreciation.
However, it is crucial to keep in mind that the total deduction cannot exceed the cost of the asset. 2.
What is the calculation order for Bonus Depreciation and Section 179? The order of deduction depends on the specific situation.
For example, if a business takes the Section 179 deduction first, they will then take the Bonus Depreciation deduction on the remaining balance. Alternatively, if the business takes the Bonus Depreciation deduction first, they can then take the Section 179 deduction on the remaining balance.
3. Can I take a deduction under Section 179 for the cost of a vehicle?
Yes, vehicles are qualifying assets under Section 179, provided that they are used primarily for business purposes.
Conclusion:
While navigating the world of tax incentives can be challenging, Bonus Depreciation and Section 179 provide excellent opportunities for businesses to reduce their tax liability, free up capital, and drive growth. By understanding the similarities and differences between these incentives and evaluating their unique circumstances, businesses stand to benefit from the potential tax savings.
Furthermore, combining these two incentives can increase tax savings, and businesses can use them to their advantage by understanding the calculation order and if they can take both deductions on the same asset. If you have any further questions about Bonus Depreciation, Section 179, or any other tax-related topics, it is always advisable to consult with a tax professional.
Tax laws can be complex and ever-changing, and seeking professional advice can help ensure that businesses are taking full advantage of all available tax incentives. In conclusion, understanding and utilizing tax incentives such as Bonus Depreciation and Section 179 can significantly benefit businesses.
Bonus Depreciation provides a percentage-based deduction on qualified assets, while Section 179 allows immediate upfront deductions up to a specific dollar limit. By combining these incentives strategically and considering factors such as the type of deduction, annual limits, and statutory end dates, businesses can maximize tax savings and free up capital for growth.
It is essential to consult with a tax professional to navigate the complexities of these incentives. By taking advantage of these opportunities, businesses can reduce their tax liability, stimulate the economy, and invest in their future success.