The Protecting Americans from Tax Hikes Act of 2015 (PATH Act) created several benefits for tax planning, not the least of which was taking the uncertainty out of common tax deductions.

Several benefits that help offset the cost of improvements to tangible property had been set to expire in 2014, but the tax extension legislation renewed and in some cases enhanced the tax-saving opportunities. Among the provisions included in the PATH Act were bonus depreciation and the Section 179 expensing election. Both apply to similar types of projects and situations, but each provision has its nuances. As businesses can only take one or the other for the same asset, careful consideration is critical to maximizing their benefits.

Basics of Bonus Depreciation

Under the bonus depreciation provision, businesses can deduct a percentage of the cost basis of investments in qualified property in the year the property was placed in service. The bonus depreciation deduction had expired in 2014, but the PATH Act extended it through 2019, with a reduction of the percentage of the cost basis that can be deducted. In 2016 and 2017, the bonus depreciation deduction is up to 50 percent of qualifying property. In 2018, it drops to 40 percent and in 2019 it is 30 percent.

Property that qualifies for bonus depreciation must be new property. It includes tangible personal property, off-the-shelf computer software and qualified leasehold improvements. Starting in 2016, bonus depreciation can also be used for an addition or improvement to the interior of nonresidential real property.

Changes under the PATH Act also affect the maximum first year depreciation cap for vehicles placed in service. Through 2017, the maximum first-year depreciation cap is $8,000. In 2018, it’s $6,400 and in 2019, the depreciation cap is $4,800.

Taxpayers can also elect to accelerate alternative minimum tax (AMT) credits in lieu of claiming bonus depreciation and increase the amount of unused AMT credits that can be claimed with the bonus depreciation.

Bonus depreciation is mandatory unless the taxpayer proactively elects out by attaching the election to their tax return.

Section 179 Expensing

Also of benefit to businesses making property upgrades is the Section 179 expensing election. The PATH Act made the Section 179 election permanent and enhanced it. Businesses can take a $500,000 deduction of investments in qualified tangible property, including off-the-shelf computer software, computers, office furniture and equipment, business vehicles with weight in excess of 6,000 pounds and other types of business equipment. Unlike bonus depreciation, new and used equipment qualify, and businesses can take deductions on property that they lease or finance. The property must be placed in service during the year the deduction is taken. Businesses can only use Section 179 expensing if they have profit. If taking the full amount of Section 179 expense creates a loss, then the amount available for Section 179 expenses is equal to what would make the company break even.

Historically, businesses had a $250,000 cap on qualified real property, including qualified restaurant property and qualified retail improvements, but as of 2016, the cap no longer applies. Air conditioning and heating unit purchases are also eligible for Section 179 expensing.

In order for the qualifying property to be eligible for the deduction, the taxpayer must use the property more than 50 percent of the time for business purposes. Taxpayers that take the deduction for property that does not meet the 50 percent deduction could have their Section 179 deduction recaptured.

The deduction comes with a limit. Taxpayers with total qualified property purchases that exceed $2 million are not eligible for the Section 179 deduction. Both the maximum deduction per asset and the phase out limit will be indexed for inflation.

Deciding Which One to Use

The two expensing deductions cannot be used on the same purchases; it’s one or the other. When deciding which one to use, it’s important to consider how the deductions’ parameters apply to your situation.

When Section 179 Makes Sense

Generally, small businesses benefit more from Section 179 expensing because of the total annual qualified purchases limit. It also may be helpful for businesses that have made several purchases of used equipment, as the bonus depreciation only applies to new property.

Companies that make qualified restaurant property improvements and qualified retail improvements that do not also meet the definition of qualified leasehold improvements will also want to opt for Section 179 expensing election.

When Bonus Depreciation Makes Sense

Taxpayers that have a net loss should opt for the bonus depreciation election because they could potentially carry-forward the bonus depreciation to a future year. Businesses cannot take the Section 179 election when they have a net operating loss.

If the qualified property is not used for business purposes at least 50 percent of the time, bonus depreciation would be the better choice. With the exception of listed property, property that qualifies for the Section 179 must be used at least 50 percent of the time for business purposes.

Whatever You Decide, Make a Plan

Both provisions require extensive planning. Taxpayers should be able to demonstrate that the deductions are used for eligible investments in property. Bonus depreciation also has more benefits in the near-term versus the long-term. With the winddown of bonus depreciation beginning in 2018, now is the time for businesses to reap the full benefits of the tax benefit.

The promise of comprehensive legislative tax reform may also have an effect on these provisions for the 2017 tax year and beyond. President-elect Donald Trump has supported removing all business deductions except for the research and development tax credit.

For more information on how to select the right deduction for your business, please contact us.

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