Renewal of Sec. 179 Expensing and Bonus Depreciation Offers Tax-Saving Opportunities
The recently enacted Protecting Americans from Tax Hikes (PATH) Act of 2015 made a number of significant taxpayer-friendly changes in the tax law, but few have a wider impact on ordinary businesses than the retroactive permanent extension of the enhanced Code Section 179 expensing rules and the five-year extension of 50 percent bonus first-year depreciation.
Enhanced Section 179 Expensing
Under Code Section 179, a taxpayer – other than an estate, a trust, or certain noncorporate lessors – may elect to deduct as an expense, rather than to depreciate, up to an annual per-taxpayer dollar limit the cost of new or used tangible personal property, off-the-shelf computer software, or qualified real property placed in service during the tax year in the taxpayer’s trade or business.
The annual dollar limit generally is reduced dollar-for-dollar by the amount of Code Section 179 property placed in service during the tax year in excess of a specified investment ceiling. Amounts ineligible for expensing due to the dollar limit can’t be carried forward and expensed in a later year. Rather, they can only be recovered through depreciation.
The amount eligible to be expensed for a tax year can’t exceed the taxable income derived from the taxpayer’s active conduct of trades or businesses. Except for certain deductions attributable to qualified real property, any amount that is not allowed as a deduction because of the taxable income limitation is carried forward to succeeding tax years.
For tax years beginning in 2014:
- The dollar limitation on the expensing deduction was $500,000.
- The investment-based reduction in the dollar limitation began to take effect when property placed in service in the tax year exceeded $2 million (the investment ceiling).
Under the 2014 limits, the Code Section 179 deduction didn’t phase out completely until the cost of expensing-eligible property exceeded $2.5 million ($2 million [investment ceiling] + $500,000 [dollar limit]).
Under pre-PATH Act law, for tax years beginning after Dec. 31, 2014, the dollar limit dropped to $25,000, and the investment ceiling dropped to $200,000. Thus, the Code Section 179 deduction was to phase out completely when the cost of expensing-eligible property exceeded $225,000 ($200,000 [investment ceiling] + $25,000 [dollar limit]).
Under pre-PATH Act law, with a few exclusions, property was eligible for Code Section 179 expensing if it was purchased for use in the active conduct of a trade or business and was:
- Tangible property that’s Code Section 1245 property (generally, machinery and equipment), depreciated under the Modified Accelerated Cost Recovery System rules of Code Section 168, regardless of its depreciation recovery period;
- For any tax year beginning in 2010 through 2014, up to $250,000 of qualified real property: qualified leasehold improvement property, qualified restaurant property, and qualified retail improvement property that’s depreciable (Under a carryover limitation for qualifying real property, no portion of the disallowed expensing could be carried to a tax year beginning after 2014.); or
- Depreciable computer software that is readily available for purchase by the general public, is subject to a nonexclusive license, and has not been substantially modified (off-the-shelf computer software), but only if placed in service in a tax year beginning before Jan. 1, 2015.
Under pre-PATH Act law, for tax years beginning before Jan. 1, 2015, an expensing election, or specification of the items or item dollar amounts to be expensed, could be revoked without the IRS’s consent. However, for tax years beginning after Dec. 31, 2014, the expensing election, and any specification made in it, could be revoked only with the IRS’s consent.
New law. The PATH Act made the following changes to the Code Section 179 expensing election:
- The $500,000 expensing limitation and $2 million phase-out amounts are retroactively extended and made permanent (Code Section 179(b)).
- For any tax year beginning after Dec. 31, 2015, both the $500,000 and $2 million limits are subject to indexing (increases) for inflation (Code Section 179(b)(6)).
- The rule that allows expensing for computer software is retroactively extended and made permanent (Code Section 179(d)(1)(A)(ii)).
- For tax years beginning after Dec. 31, 2015, the exclusion of air-conditioning and heating units no longer applies (Code Section 179(d)(1)).
- The rule that allows an expensing election or election specification to be revoked without the IRS’s consent is made permanent (Code Section 179(c)(2)).
- Qualified real property is eligible to be expensed for tax years beginning before 2016 (Code Section 179(f)(1)), but no portion of disallowed expensing of the qualified real property can be carried to a tax year beginning after Dec. 31, 2015 (Code Section 179(f)(4)). For tax years beginning after Dec. 31, 2015, expensing of qualified real property is made permanent without a carryover limitation (Code Section 179(f)), and the $250,000 expensing limitation with respect to qualifying real property is eliminated (Code Section 179(f)).
Bonus First-Year Depreciation
Under pre-PATH Act law, Code Section 168(k) generally allowed an additional first-year depreciation deduction (bonus first-year depreciation) equal to 50 percent of the adjusted basis of qualified property placed in service before Jan. 1, 2015 (before Jan. 1, 2016, for certain property; see below). The bonus depreciation was allowed for both regular tax and alternative minimum tax purposes, but was not allowed for purposes of computing earnings and profits.
The basis of the property and the depreciation allowances in the year of purchase and later years were appropriately adjusted to reflect the bonus depreciation deduction. A taxpayer could, for a tax year, elect out of bonus depreciation for the assets, in one or more specified classes of property, placed in service during the tax year.
In general, an asset qualified for the bonus depreciation allowance if:
- It fell into one of the following categories: most tangible personal property and land improvements other than buildings and building improvements, computer software (except for certain computer software acquired in an acquisition of a business), qualified leasehold improvement property, or certain water utility property.
- It was placed in service before Jan. 1, 2015. (Certain long-production-period property and certain aircraft could be placed in service before Jan. 1, 2016.)
- Its original use commenced with the taxpayer. Original use was the first use to which the property is put, whether or not that use was by the taxpayer.
New law. The PATH Act extended bonus depreciation for qualified property placed in service during 2015 through 2019 (subject to a phase down) and through 2020 (subject to a phase down) for the long-production-period property and aircraft mentioned above.
Thus, eligible taxpayers will be able to claim:
- A 50 percent bonus depreciation allowance for qualified property placed in service in 2015 through 2017.
- A 40 percent bonus depreciation allowance for qualified property placed in service in 2018.
- A 30 percent bonus depreciation allowance for qualified property placed in service in 2019 (Code Section 168(k)).
The reduced percentages apply to the long-production-period property and aircraft placed in service one year later than shown in the list above.
Additionally, the PATH Act substituted, as the category of building improvements eligible for bonus depreciation, qualified improvement property for qualified leasehold improvement property. And the PATH Act provided a placed-in-service rule, making it easier for fruit and nut plants to meet the deadlines for bonus depreciation discussed above.
The above changes, which were enacted late in 2015, are retroactive. Thus, a fiscal year taxpayer that, for its tax year ending in calendar year 2015 (the 2015 year), could benefit from the bonus depreciation, but filed its 2015 tax year return before the retroactive extension of bonus depreciation, might want to consider filing an amended return.
Under Code Section 179 expensing, an eligible taxpayer can elect to deduct up to all of the cost of qualifying property in the tax year the qualifying property is placed in service, even if the property is placed in service on the last day of the year.
However, as noted above, besides not being available to certain taxpayers (estates, trusts, and many noncorporate lessors), a number of other limitations apply. The expensing deduction is subject to the annual dollar limitation and investment ceiling discussed above. Also, as discussed above, the expensing deduction is further limited to taxable income from the taxpayer’s active trades or businesses, with any amount that can’t be deducted because of this limitation carried over indefinitely to later years. The property subject to expensing must be purchased for use in the active conduct of a trade or business, not merely for the production of income.
Bonus depreciation, while not providing as quick or as large a deduction as Code Section 179 expensing, is not subject to an annual dollar limitation or investment ceiling. Bonus depreciation is available only for property whose original use begins with the taxpayer, but the property, unlike Section 179 property, can be used in a trade or business or for the production of income.
However, while the 50 percent bonus depreciation portion isn’t subject to the depreciation conventions (deemed half-year or mid-quarter conventions that determine first-year depreciation deductions based on when the convention deems property to be placed in service), the conventions do apply to the other first-year depreciation deductions allowed with respect to qualified property.
In many cases, a taxpayer may be able to use both methods.
Richard H. Sternberg, J.D., LL.M, is a senior editor/author with Thomson Reuters Checkpoint within the Tax & Accounting business of Thomson Reuters. Richard concentrates in tax accounting, with further emphasis on cost recovery and the...