100% Bonus Depreciation Expires in 2022

Are you planning to make a significant capital investment? If so, all businesses, including lessors and lessees, may want to make those purchases soon, as the tax-saving opportunity created by 100% bonus depreciation is set to expire at the end of the year, barring additional action from Congress. This means that starting on January 1, 2023, bonus depreciation will begin to phase out over four years, ultimately ending in 2026.

Unlike standard amortization, bonus depreciation allows a taxpayer to immediately deduct a percentage of the property value in the year it was placed in service. In other words, it facilitates immediate tax savings. Therefore, when costs are rising, this is one valuable incentive businesses should consider leveraging, the key details of which we have summarized below.

Bonus Depreciation: A Primer

Depreciation is “an income tax deduction that allows a taxpayer to recover the cost or other basis of certain property. It is an annual allowance for the wear and tear, deterioration, or obsolescence of the property.” The property value is deducted over several years until the value is recovered or the property reaches the end of its useful life, whichever comes first.

Bonus depreciation allows the taxpayer to capture more of the property value in the first year, resulting in a favorable tax deduction upfront. Before the Tax Cuts and Jobs Act (TCJA), the bonus depreciation rate was 50% and only applied to a new property when first introduced in 2002. Then, it was just 30%. It expanded to 50% a year later. TCJA temporarily expanded bonus depreciation to 100% – but only until December 31, 2022.

US Bank provided this example of how bonus depreciation works while still at 100%.

 

Certain types of new and used property placed into service after September 27, 2017, and before January 1, 2023, qualify for 100% expensing. Generally, machinery, equipment, computers, appliances, and furniture qualify. The TCJA added specific film, TV, and live theatrical productions to the list of qualified properties. Types of property that do not qualify for 100% bonus depreciation include:

• Land
• Buildings
• Property with a useful life of one year or less
• Intangible property
• Property that was disposed of in the year it was purchased
• Leased property
• Property that’s not used in an income-producing activity

Instead, these property types would follow a standard depreciation and amortization schedule.

Used property qualifies for 100% bonus depreciation if it’s new to the taxpayer and meets all the following requirements:

• The property wasn’t purchased from a related party or a component member of a controlled group of corporations.
• The property’s taxpayer basis is separate from the seller’s adjusted basis.
• The property’s basis is separate from that of a decedent.
• The property’s basis is separate from that a like-kind exchange or involuntary conversion.

There are other exclusions and limitations that taxpayers should consider. For example, property that’s partially used for personal reasons – like a car – can qualify for partial bonus depreciation if at least 50% of the car’s use is for business purposes. This is called listed property.

100% bonus depreciation applies to property with a useful life of 20 years or less. This is an especially important rule considering that the CARES Act changed the definition of qualified improvement property from a 39-year useful life to a 15-year depreciation – making it eligible for 100% bonus depreciation.

Bonus Depreciation In 2022 and Beyond

Beginning on January 1, 2023, bonus depreciation will begin to phase out. Its value is reduced by 20% for four years and then phases out entirely beginning in 2027. Bonus depreciation rates breakdown as follows:

• 2022: 100%
• 2023: 80%
• 2024: 60%
• 2025: 40%
• 2026: 20%
• 2027: N/A

Cost Segregation and Bonus Depreciation

Land and buildings generally don’t qualify for 100% bonus depreciation; however, individual components can. That’s where a cost segregation study comes in.

Cost segregation studies identify separate tangible components of real property. These components are usually subject to shorter life spans and therefore eligible for bonus depreciation. For example, in an apartment building, eligible property identified in a cost segregation study might include new carpets, furniture, and laundry and kitchen appliances.

Both acquired, and self-constructed properties can benefit from a cost segregation study. For acquired property, eligibility extends to personal property “acquired by the taxpayer and used in the construction by the taxpayer (or a third party under contract with the taxpayer) of new real property, or the expansion, refreshment, or restoration of the taxpayer’s existing real property.”

Eligible self-constructed property is that which is “manufactured, constructed, or produced by the taxpayer and used in the construction by the taxpayer (or a third party under contract with the taxpayer) of new real property, or in the expansion, refreshment, or restoration of the taxpayer’s existing real property used in its trade or business or for the production of income.” In either case, the property still must be acquired and placed in service before the December 31, 2022, end date.

Companies need to plan and capture this savings opportunity since this is the last year of 100% bonus depreciation. This is especially true for cases where a cost segregation study is involved.

Contact Us

If you have questions about the information outlined above or would like to determine if your planned purchases qualify for 100% bonus depreciation, click here to contact us. We look forward to speaking with you soon.

©2022 Klatzkin & Company LLP. The above represents our best understanding and interpretation of the material covered as of this post’s date. The content is provided for informational purposes only and does not constitute accounting, tax, or financial advice. Please consult your advisor concerning your specific situation.