Bonus Depreciation Vs. Section 179 Expensing: Which Should You Choose?

8 minute read

Depreciation can be a confusing topic for even seasoned experts come tax season. Questions such as how much depreciation one can take, what type of depreciation is available and when a property is eligible are just a few of the inquiries people ask their CPA every spring. It can be a confusing and misunderstood topic, so let’s go over the basics first, and then we’ll cover a more advanced theme: the difference between bonus depreciation and Section 179 expensing.

What Is Depreciation?

At its core, depreciation is what allows a taxpayer to recover the cost of property purchased over a determined period of time. This is recovered through an income tax deduction, and the amount that can be deducted depends on various factors. All types of business entities that purchase property are eligible to take depreciation deductions, though some industries may be subject to special rules. In addition, special rules allow larger depreciation deductions in earlier years after certain property is initially purchased. 

Requirements for Depreciation Deduction

There are several requirements an asset must meet in order to be depreciated. It must be owned by the taxpayer, and it must be used in the business or income-producing activities of the taxpayer. It also must have a determinable useful life — meaning that it wears out, decays or becomes obsolete over a predictable number of years. Lastly, it must be expected to last more than one year.

Keep in mind that certain types of property are ineligible for depreciation:

  • Land (however, certain land improvements can qualify)
  • Property that is placed in service and disposed of in the same tax year (i.e., inventory or technical manuals)
  • Intangible property (which may be amortized instead)
  • Term interests in property for which the remainder interest is held by a person related to the taxpayer

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General Methods of Depreciation

While there are some special methods of depreciation, which we’ll outline further below, there are three general ways of using depreciation:

  1. Straight-Line Depreciation: This is when property depreciates at the same percentage over each year in the recovery period. For example, a property with a 15-year recovery period is purchased for $15,000. Each year, the depreciation deduction will be $1,000 under the straight-line method. This is the only allowable method for 27.5-, 31.5- and 39-year property, as well as some 15-year property.
  2. 150% Declining Balance: Under this method, property may be depreciated for the first year at 150% of the amount allowed in the first year under the straight-line method. For example, property purchased for $15,000 can have a first-year depreciation of $1,500 instead of the $1,000 under the straight-line method. This method tends to give significantly higher deductions in years two through five, and is the default method for property with recovery periods of 15 and 20 years.t cannot be used for assets with recovery periods longer than 20 years.
  3. 200% Declining Balance: Similar to the method above, this gives property depreciation equal to 200% of the amount allowed under the straight-line method in the first year. A $15,000 property would have a $2,000 depreciation for the first year. This is the default method for property with recovery periods of 3, 5, 7 and 10 years. Assets with recovery periods longer than 10 years cannot use this method.

Special Methods of Depreciation

In addition to the typical methods of depreciation, there are two special types of depreciation. The first one is bonus depreciation, which the TCJA extended while increasing the allowance amount to 100% of the purchase cost of the property in the year it’s placed in service. Bonus depreciation will be phased out in 2023 and cut off completely by 2027.

Only property with a useful life of 20 years or less is eligible for bonus depreciation. In addition, generally the property must have a useful life of over a year and its use must originate with the purchaser — which means no used property, with very limited exceptions.  

To illustrate, imagine Jan, a businesswoman purchases new desks and filing cabinets for her office building. These are classified as seven-year property. Jan may depreciate the full amount of the desks in the year she places them in service. Alternatively, if Jan purchases desks and filing cabinets at an auction for the office building, the desks and cabinets didn’t originate their use with Jan — and therefore they are ineligible for bonus depreciation. 

A second special method of depreciation is called Section 179 expensing, which is a permanent tax provision for increased expensing of property purchases. It’s limited to $1M but adjusted annually for inflation (2021 = $1.05M). Section 179 expensing phases out at a dollar-for-dollar amount if the total property purchases in the year exceeds $2.5M, again adjusted for inflation (2021 = $2.62M). No purchase exceeding the sum of the limitation and the phase out floor ($3.67M in 2021) can be expensed.    

Going back to our example, if Jan purchases $3M of property in 2021, She may expense $670K – the difference between the full phase-out amount and the actual amount paid.

Bonus Depreciation Vs. Section 179 Expensing

For an easy, fast comparison, let’s look at both special methods of depreciation.

Bonus Depreciation:

– Temporary provision — begins phase-out in 2023, gone in 2027

– Applies to property with class lives ≧20 years

– Can deduct 100% of qualified property — no limits

– May be used to reduce income below zero (generate a loss)

– Can only be used for property that originates with the taxpayer 

– Reported on Form 4562, part

Section 179 Expensing:

– Permanent provision for property with class lives ≧ 20 years

– Cannot reduce income below zero

– May be taken for property that has already been used

– Capped at $1.05M for 2021

– Phase-out begins at 2.62M, with no expensing allowed after $3.67M

– May be used for some property that does not qualify for bonus 

– Reported on Form 4562, part

Getting the Most Out of Depreciation

If you are looking to save on taxes, depreciation can be a powerful strategy. Good tax planners, however, use a variety of strategies each year to save money. Bonus depreciation and Section 179 Expensing can be used for different assets in the same tax year to maximize benefits. Tools such as Corvee tax planning software help taxpayers quickly find the strategies available to them. Request a demo today.

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