Bonus depreciation

Article Dean Dorton

By: Matt Smith, CPA | msmith@deandorton.com

Tax planning for 2020 is considerably more complicated for many taxpayers due to the following major factors:

  • The impact on business profits or compensation income of the COVID-19 pandemic, including uncertainty about the ultimate tax treatment of expenses paid by PPP loan funds when the loan qualifies to be forgiven, and
  • The current uncertainty about future tax law changes after the recent federal elections.

Discussions of all the “what ifs” are beyond this article’s scope, and the planning ideas that follow focus on the short-term—reducing 2020 taxes. We recommend you consult your tax advisor if you believe your situation is particularly impacted by unusual circumstances.

Maximize pre-tax deductions. Determine if you are on track to have 2020 maximum amounts withheld from your paycheck for your retirement plan contributions, HSA contributions, dependent care benefits, and other available pre-tax options. If you are not going to maximize these, consider having additional amounts withheld from year-end bonuses, if possible, and consider increasing these amounts for 2021.

Capital gains and losses. If you have realized net capital gains during 2020, consider realizing capital losses before the end of the year to offset the gains. Remember that net long-term losses can be used to offset net short-term capital gains which otherwise would be taxed as ordinary income. Also, be aware of the “wash sale” rules if you are inclined to reinvest in a security you sell at a loss.

Bonus depreciation & Section 179. Businesses should consider these tax breaks related to fixed asset acquisitions:

  • Special “bonus depreciation” allowance. For 2020, 100% of the cost of qualifying property (including used assets) is deductible if the property is placed in service by year-end. This deduction can create or increase an existing business loss. Note: Because its requirements are much less restrictive, 100% bonus depreciation usually makes Section 179 not applicable.
  • Section 179 depreciation deduction. In 2020, individuals and business entities can elect to deduct up to $1,040,000 of qualifying business property cost in the year the property is placed in service. The deduction is reduced dollar-for-dollar for qualifying property cost greater than $2,590,000. This deduction is available only to the extent of positive business taxable income.

Self-employed retirement plans. If you have self-employment income and don’t have a retirement plan in place to shelter any of it, you may qualify to use a Self-Employed Plan (SEP). A SEP contribution deduction is allowed for 2020, even if the SEP is created and funded at any time up to the due date, including extensions, of your 2020 income tax return in 2021. Depending on the amount of self-employment income, you could fund (and deduct) up to $57,000 for 2020.

Required minimum distributions (RMDs). The CARES Act waives required minimum distributions during 2020 for IRAs and retirement plans. Individuals with traditional IRAs and most individuals with employer-sponsored qualified retirement plan accounts must take minimum annual distributions from the account upon reaching a certain age, most recently changed to 72.

Charitable contributions. Depending on your situation, it may be beneficial to accelerate planned 2021 charitable contributions into 2020 or to defer 2020 contributions into 2021 to bunch them into the same year for greater tax savings.

Annual gifting. You may give your children and others up to $15,000 each in 2020 without any gift tax consequences. This annual exclusion is calculated on a per donee basis and no carryover is allowed for the unused exclusion. Consider making year-end gifts to fully utilize this year’s annual exclusion.

Roth IRAs. With individual tax rates at the lowest levels in recent memory, consider converting traditional IRAs to Roth IRAs. The current tax cost from a conversion done now may turn out to be a relatively small price to pay for completely avoiding potentially higher future tax rates on the account’s earnings. Also consider making a backdoor Roth IRA contribution, if your current income level is too high to make a direct Roth IRA contribution. A backdoor Roth IRA contribution consists of making a nondeductible IRA contribution followed by converting the contributed funds to a Roth IRA. The rules regarding this are very particular, so please consult with your tax advisor regarding this strategy.

HSAs & FSAs. Health Savings Accounts (HSAs) and Flexible Savings Accounts (FSAs) are two separate tools to convert your dollars spent on medical expenses from post-tax into pre-tax, potentially saving you up to 42% of the cost.  An HSA is a bank account set up to pay for medical expenses and must be paired with a high-deductible health plan. FSAs allow you to direct some of your wages into a pre-tax account, and your employer will reimburse you from the account for your documented medical expenses.  Specific funding rules and limits apply to these accounts.

S Corporation and partnership losses. If your S Corporation will generate a tax loss this year, consider whether you have enough basis in the stock (or in loans you’ve made to the corporation) to take the full loss. If you don’t, additional investments should be considered. Similar considerations can arise in some situations with partnerships expecting tax losses.

Excess Business Loss. The Tax Cuts and Jobs Act (TCJA), passed in late 2017, introduced a limitation on business losses deductible by individuals and other non-corporate taxpayers (trusts and estates) against non-business income.  Specifically, the TCJA disallowed net tax losses from active businesses over $250,000 ($500,000 for joint filers), adjusted annually for inflation. For pass-through entities, this is calculated at the owner level, as tax-paying persons combine all business activities when determining overall net business income or loss. Disallowed losses are treated as net operating loss carryforwards to the following year. Under the TCJA, the excess business loss (EBL) limitation was effective for 2018 through 2025. The CARES Act retroactively postponed implementation of the EBL limitation until 2021. This postponement and other available income tax incentives—such as 100% bonus depreciation and net operating loss carrybacks—mean 2020 could be the optimal year to accelerate deductions in your business.

This article was originally published in News & Views (Dean Dorton’s quarterly newsletter).

Go to News & Views

Article Dean Dorton

You are probably aware that late last year, The Tax Cuts and Jobs Act (TCJA) made substantial alterations to the tax laws, resulting in sweeping changes to individuals and businesses. Although not specifically addressing the energy sector, many of these modifications will have a positive impact on energy companies.

One of the changes effectively lowered the cost of capital equipment acquisitions by changing the rules for bonus depreciation. Under previous tax rules, 50% bonus depreciation was available for certain “new” eligible property used in a business or in an income producing activity. By accelerating the deduction for machinery, most software, and real property,  50% bonus depreciation was able to lower the true economic cost of these assets. Under TCJA the bonus depreciation is now 100%, generally only applying to property that is acquired and placed in service after September 27, 2017.

Bonus depreciation is available for new and the majority of previously used property, as opposed to before the Act, where property was required to be new. However, the used property will now qualify unless the taxpayer both (1) previously used the property and (2) acquired the property in certain forbidden and tax free transactions, or through a related person or entity. Similar to before, taxpayers should sometimes make the election to turn down bonus depreciation (an “election-out”). Sole proprietorships and entities taxed under the rules for partnerships and S corporations still want to make sure that they don’t “waste” these deductions by applying them against lower-bracket incomes in the year property was placed in service when given an opportunity to apply them against higher bracket income in later years. Under the Act, entities taxed as “regular” corporations are taxed at a flat rate.

While these are the major aspects of bonus depreciation, the TCJA made several smaller significant changes. Even without amendment, TCJA bonus depreciation is a complicated area with tax implications for transactions that are not simple asset acquisitions. There are phase-outs away from 100% over the next few years until bonus deprecation is generally no longer available under current law, beginning after December 31, 2026.

The multitude of changes brought by TCJA can impact your business, with bonus depreciation being only one. Consult with your tax advisor when considering asset acquisitions to get the most benefit from tax savings from these changes in the law.

For more information, contact your Dean Dorton advisor or Bert Layne, CPA at blayne@deandorton.com.

Article Dean Dorton

This is the first in a five-part series that highlights the segments of the newly enacted Tax Cuts and Jobs Act and how it impacts the real estate industry.

We will focus on the following topics:

  1. Cost recovery and expensing of depreciable assets
  2. 20% deduction for qualified business income
  3. Excess business losses and net operating losses
  4. Business interest expense limitations
  5. Like-kind exchanges, rehabilitation credit, and qualified opportunity zone gain deferral

In our first installment, we will discuss highlights of the Act and how it impacts capitalization and cost recovery of assets.

First, let’s discuss a section of the Act which may impact assets placed in service during the 2017 tax year.

Bonus depreciation

Prior to September 27, 2017, new assets with modified accelerated cost recovery system (MACRS) lives of 20 years or less were eligible for 50% expensing in their first year in service. For assets acquired and placed in service after September 27, 2017, bonus depreciation has been expanded to include used assets (as long as the use is original to the taxpayer) and increased to 100% expensing. This means certain assets can be fully expensed in their year of purchase. Please note that assets that had a written binding contract prior to September 27, 2017will not be eligible for 100% bonus depreciation. Assets purchased from a related party or controlled group, or received through gift or inheritance, are not eligible for bonus depreciation.

Bonus depreciation at 100% of cost will be available for assets placed in service from September 27, 2017 to January 1, 2023. Then it will be phased out over the period from January 1, 2023 to December 31, 2026 and will be fully eliminated after December 31, 2026. Taxpayers will still be able to elect out of bonus depreciation if they choose.

States will have to decide whether they will follow the changes to federal depreciation rules. If they do not follow the federal law, then there will be adjustments for state purposes to be considered in tax planning.

The next two changes only impact assets placed in service after December 31, 2017.

Section 179 expensing

The Section 179 election allows for 100% expensing for eligible assets up to certain annual limits. The limit for expensing annually increases to $1 million for eligible assets placed in service after December 31, 2017. Section 179 expensing is limited based on the amount of total assets placed in service. This “phasedown” has been increased to $2.5 million after December 31, 2017. This election is only allowable up to net taxable income.

Eligible Section 179 property is tangible personal property, computer software and a newly created “qualified real property”. The inclusion of qualified real property will greatly expand the ability to expense fixed asset additions. Qualified real property includes the newly created qualified improvement property (discussed below), as well as certain structural improvements to the nonresidential real property. This includes roofs, HVACs, fire protection and alarm systems, and security systems. Qualifying property has also been expanded to include certain depreciable personal property used to furnish lodging (e.g., beds, refrigerators, ranges, et cetera). There has been no change related to residential rental property’s ability to take Section 179 on tangible personal property.

Qualified improvement property

Previously, there were three types of qualified improvements to real property—qualified leasehold improvements, qualified restaurant improvements, and qualified retail improvements. All three definitions varied and had different implications for the ability to currently expense improvements. The new law provides for a single qualified improvement property. This property is any improvement to the interior portion of a building placed in service after the original building is placed in service, and is effective for assets placed in service after December 31, 2017. Qualified improvement property has a 15-year recovery period (20-year ADS period), which means it will be eligible for the 100% bonus depreciation from January 1, 2018 through December 31, 2022, as well as Section 179 expensing.

We have not discussed the interaction of the new cost recovery options with the tangible asset regulations that were issued in 2014 that provided guidelines on capitalization of assets versus expensing as repairs. These will need to be considered when making elections related to 100% bonus expensing versus Section 179 expensing. There will also be interaction with the 20% deduction for qualified business income and the limitation on interest expense, which we will discuss in further detail in our next installment.

Read All Tax Cuts and Jobs Act Articles

Article Dean Dorton

…But Should They?

Bonus depreciation allows businesses to recover the costs of depreciable property more quickly by claiming additional first-year depreciation for qualified assets. The Protecting Americans from Tax Hikes Act of 2015 (the PATH Act) extended 50% bonus depreciation through 2017.

The break had expired December 31, 2014, for most assets. So the PATH Act may give you a tax-saving opportunity for 2015 you wouldn’t otherwise have had. Many businesses will benefit from claiming this break on their 2015 returns. But you might save more tax in the long run if you forgo it.

What assets are eligible

For 2015, new tangible property with a recovery period of 20 years or less (such as office furniture and equipment) qualifies for bonus depreciation. So does off-the-shelf computer software, water utility property and qualified leasehold-improvement property.

Acquiring the property in 2015 isn’t enough, however. You must also have placed the property in service in 2015.

Should you or shouldn’t you?

If you’re eligible for bonus depreciation and you expect to be in the same or a lower tax bracket in future years, taking bonus depreciation (to the extent you’ve exhausted any Section 179 expensing available to you) is likely a good tax strategy. It will defer tax, which generally is beneficial.

But if your business is growing and you expect to be in a higher tax bracket in the near future, you may be better off forgoing bonus depreciation. Why? Even though you’ll pay more tax for 2015, you’ll preserve larger depreciation deductions on the property for future years, when they may be more powerful — deductions save more tax when you’re in a higher bracket.

We can help

If you’re unsure whether you should take bonus depreciation on your 2015 return — or if you have questions about other depreciation-related breaks, such as Sec. 179 expensing — contact us.