How the TCJA Changed First-Year Depreciation Rules
The Tax Cuts and Jobs Act (TCJA) includes changes to several first-year depreciation rules.
Under IRC Section 168(k), certain equipment can be completely expensed if it was purchased after September 27, 2017 and before January 1, 2023.
Additionally, under the TCJA, for the first time ever, the additional first-year depreciation deduction is allowed for used as well as new property (although the former is ineligible under certain circumstances).
Furthermore, for tax years beginning in 2018, the dollar limitation on Code Sec. 179 expensing is $1 million (up from $510,000), and the investment-based reduction in the dollar limitation starts to take effect when expensing-eligible property placed in service in the tax year exceeds $2.5 million (up from $2,030,000).
However, under long-standing rules that weren’t altered, the Code Sec. 179 expensing deduction is limited to taxable income from all of the taxpayer’s active trades or businesses. In general, any amount that cannot be deducted because of the limit can be carried forward to later years until it is fully deducted.
Additionally, a category of improvements related to nonresidential realty may be expensed under Code Sec. 179, but it is not currently eligible for 100% bonus depreciation, although this could change. Another category is newly eligible for Code Sec. 179 expensing under the TCJA, but there is no parallel provision that would allow property that falls under this classification to become eligible for bonus depreciation even if technical corrections are enacted.
Qualified real property acquired by purchase and that is intended for use in the active conduct of a trade business is eligible for Code Sec. 179 expensing. Effective for property placed in service in tax years beginning after Dec. 31, 2017, it consists of two categories: qualified improvement property and a grab bag of specific enhancements.
However, Section 179 has some limits. For example, if a taxpayer has $800 in taxable income and purchases $1,000 of equipment in a taxable year, only $800 would be deductible under Section 179. The unused portion would carry forward to the next year. Conversely, if that same equipment is expensed using bonus depreciation, the full amount would be deductible in the year of purchase.
Although taxpayers generally benefit by accelerating the timing of deductions, there are situations in which accelerating deductions is offset by other considerations.
One of those is the expiration of net operating losses (NOLs), charitable contributions or credit carryforwards. That is, the use of any of these is limited by a taxpayer’s taxable income, and their carryover expires after a specified time.
By not claiming Code Sec. 179 expensing or by electing out-of-bonus depreciation, a taxpayer increases their current-year taxable income but can offset the increase by use of the expiring tax benefit and receive the deferred depreciation deductions in future years.
Expensing comes out ahead under such circumstances because a taxpayer who uses Code Sec. 179 makes an annual election to do so on a property-by-property basis and specifies the elected-for part of a property’s cost.
By contrast, bonus depreciation automatically applies to all eligible properties at their full costs (less any amounts expensed under Code Sec. 179). The taxpayer may elect out-of-bonus depreciation but can do so only for one or more full classes of property, such as all five-year MACRS property. To say it plainly, a taxpayer can’t pick and choose which properties they want to write off via 100 percent bonus depreciation.
Under the Code Sec. 263A UNICAP rules, a taxpayer must include in inventory costs the “allocable costs” of “property” that is inventory and capitalize those of any other items. The allocable costs include those that are direct and indirect, to the extent of the property's proper share of that part (or all) of the total.
Under Reg. § 1.263A-1(e)(3)(ii)(I), amounts claimed for depreciation are required to be capitalized under Code Sec. 263A. By contrast, under Reg. § 1.263A-1(e)(3)(iii), amounts expensed under Code Sec. 179 are indirect costs that are not required to be capitalized. Thus, for those subject to the Code Sec. 263A UNICAP rules, Code Sec. 179 expensing is a clear winner for those who are eligible to use it.
As you can see, you have several choices when applying the various first-year depreciation rules, so speak with your clients about their goals and review all the options before making a selection.
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Craig W. Smalley, MST, EA, has been in practice since 1994. He has been admitted to practice before the IRS as an enrolled agent and has a master's in taxation. He is well-versed in US tax law and US Tax Court cases. He specializes in taxation, entity structuring and restructuring, corporations, partnerships, and individual taxation, as well as...