The Protecting Americans from Tax Hikes Act of 2015 (PATH Act) significantly changed two depreciation tax breaks — Section 179 expensing and bonus depreciation — in ways favorable to many companies. To the extent possible, you’ll want to consider these changes when planning investments in depreciable assets.
Section 179 expensing
Among the act’s many provisions is an expansion of Sec. 179 expensing. Without the PATH Act, a company’s maximum Sec. 179 deduction would have been $25,000, and the deduction would have phased out after its depreciable asset investments topped $200,000. The PATH Act has permanently extended the deduction — boosting the limit to $500,000 with a $2 million phaseout. Both amounts will be indexed for inflation.
For 2016, businesses can deduct up to $500,000 in qualified purchases. But after a company’s purchases hit $2.01 million, the amount it can deduct is reduced by one dollar for every dollar spent. Suppose a company bought $2.31 million worth of qualifying equipment. Using Sec. 179 expensing, it would be able to deduct $200,000, or the $500,000 expensing limit less the $300,000 by which its purchases exceeded $2.01 million.
Under the PATH Act, Sec. 179 expensing — traditionally available for depreciable tangible personal property such as vehicles, equipment and computers — continues (though special limits apply to the total amount of depreciation that can be claimed for vehicles). In addition, for tax years beginning after 2015, the act eliminates the $250,000 cap for “qualified real property,” including leasehold and retail-improvement property as well as qualified restaurant property. These now are subject to the same $500,000 cap as other expenditures. The PATH Act also eliminates, for tax years after 2015, the exclusion on air-conditioning and heating units that previously had been in place.
Businesses can use Sec. 179 expensing to cover both new and used equipment, but with one caveat: The company has to record a profit for the year — it can’t use Sec. 179 to increase or create a loss. While it’s still possible to elect Sec. 179 on assets in a loss year, the amount used is limited to profits — any excess is available to be carried forward to future years.
The PATH Act extended bonus depreciation — also known as Section 168 depreciation — for most new, not used, property placed in service until the end of 2019. Bonus depreciation offers another way to accelerate an asset’s depreciation.
Property placed in service between 2015 through 2017 may qualify for a bonus 50% first-year depreciation. For most qualifying assets, that amount drops to 40% in 2018 and 30% in 2019. Most property placed in service after calendar year 2019 won’t be eligible for bonus depreciation, unless Congress again extends this provision.
Bonus depreciation applies to many types of assets with depreciable lives of no more than 20 years — including machinery, equipment and computer software. Until the PATH Act, bonus depreciation often was reserved for “qualified leasehold-improvement property.” Now it’s available for “qualified improvement property.” This means improvements don’t have to be subject to a lease. They typically can include improvements to the interior portions of nonresidential buildings, as long as they don’t enlarge the building and aren’t attributable to the internal structural framework, the elevator or the escalator. The improvements need to occur after the building is first placed into service.
Businesses taking advantage of Sec. 179 expensing or bonus depreciation typically depreciate the remaining value of assets using their regular depreciation methods. These methods enable companies to reduce their taxable income and lower their tax bills. So you’ll want to plan asset purchases and investments to maximize your ability to leverage these provisions, if possible.
One strategy would be to delay some purchases to keep overall investments in a given year at or below the $2 million (as adjusted for inflation) limit, after which Sec. 179 expensing is reduced. On the other hand, to take maximum advantage of the bonus depreciation provision, you might try to accelerate some purchases. Doing so will enable you to apply a higher bonus depreciation percentage than you’ll be able to in subsequent years, when the depreciation limit declines.
Best of both worlds
You may be able to combine strategies regarding the two provisions to slash your tax bill. Say a company invests $1 million in equipment that qualifies under both categories of depreciation. Because bonus depreciation is calculated after Sec. 179 expensing, the business could expense the first $500,000 under Sec. 179 and then apply bonus depreciation to the remaining $500,000. Any remaining basis would be subject to regular Modified Accelerated Cost Recovery System (MACRS) depreciation.
Although one or both of these tax provisions may benefit your business, the rules can be complicated. Your accounting professional can provide additional expertise.