Bonus depreciation and Section 179 are tax write-offs that allow businesses to claim depreciation on certain property earlier than traditional tax methods allow.
These business tax deductions have been around for decades but underwent significant changes from the CARES Act and the Tax Cuts and Jobs Act (TCJA) in recent years. Both acts have made it easier for businesses to take advantage of depreciation, putting more cash in their pockets to invest in their businesses sooner.
But which method of accelerated depreciation is best—and should your small business take advantage at all? That's what we cover below. By the end of this article, you should know which method you want to use and what steps to take to get the most out of your next tax season.
Bonus Depreciation vs. Section 179
Bonus depreciation and Section 179 are two distinct tax provisions that allow businesses to deduct the cost of qualified equipment purchases, including:
- Computer software: Software that's necessary for your business and common in your industry, such as a restaurant's point of sale software.
- Tangible property: Physical assets purchased for business purposes and with a recovery period of 20 years or less. Examples include furniture, flooring, and appliances.
- Interior improvements to nonresidential property: This includes commercial building renovations and leasehold improvements (for example, renovations to a business's office space). Also known as qualified improvement property. Only applies to real estate, not rental properties.
However, they have key differences in terms of eligibility, limits, and application. Consider the following:
When to Choose Bonus Depreciation vs. Section 179
Choosing the right deduction method isn't about how much you'll save. With any method, business owners will (eventually) deduct the entire cost of your purchase. The main difference is when you get that benefit. And the "right" time to get that benefit will depend on your business goals.
In general, whichever method you choose should fit squarely within your business's larger plans. Let's take a look at how to determine which method is right for your business:
When to Choose Bonus Depreciation
You can consider going the bonus depreciation route when your tax liability is high— especially if you expect to have a smaller tax liability in the following years—as bonus depreciation will reduce taxable business income. Additionally, if it creates a net loss, the bonus depreciation deduction may be the better option, as you can roll over that loss into subsequent years.
When to Choose Section 179
If you purchase several assets within the same asset class but only want to claim a portion of the possible depreciation, Section 179 could be a good choice for you.
You might also choose Section 179 if you want a larger deduction in that first year. As long as your purchase meets eligibility requirements, you can deduct 100% of the purchase price of an asset—as opposed to bonus depreciation of 80%.
But bear in mind that vehicle depreciation for business use is subject to further rules and restrictions when using accelerated depreciation methods.
When to Choose Both
In some situations, you might want to use both bonus depreciation and Section 179. For example, if you want to depreciate your business assets by more than the Section 179 limit, using a combination of methods can help you do that. Another option is to use Section 179 to depreciate your business income down to $0—and then leverage bonus depreciation to create a net loss, which can often be carried forward to reduce future liabilities and make a business eligible for additional tax credits.
You may want to use both methods when you are depreciating assets across different classes, as bonus depreciation has to be applied to all assets within the same class, but you can pick and choose which assets to apply the Section 179 deduction to.
When to Choose Neither
If you plan to sell your equipment before the end of its natural life, consider using the straight-line depreciation method. Why? Because when you sell your equipment, the sales price will be subject to recapture if you depreciate with bonus depreciation, section 179, or both.
Recapture occurs when the IRS reclaims previously deducted tax benefits when the business sells the depreciated asset. This leads to an additional tax liability.
Additionally, if you're eligible for the Section 199A "pass-through" deduction, using an accelerated depreciation method may reduce the 199A deduction benefit.
Strategize with Professionals
Choosing how and when to depreciate assets is tricky, and mistakes can be costly. That's why it's so important to work with a business tax planner when making your decision.
Remember that a tax preparer is someone who can efficiently prepare and file your annual tax returns. But that doesn't mean they can help you create a tax strategy, even if they are a CPA.
Tax planners (aka tax advisors or tax consultants) take a proactive approach to minimize your tax liability. They analyze your business's financial situation, recommend tax-efficient strategies, and provide long-term tax planning advice in consideration of financial goals, operational goals, and investments. So if the tax code is tying you up in knots, get some help.
How Does Bonus Depreciation Work?
Bonus depreciation rules allow you to speed up depreciation by deducting a significant portion of the eligible asset's cost in the first year. You then spread out the remaining cost over several years until the asset has been fully depreciated. It's a great way to get some much-needed tax savings.
There is no annual limit on how much you can claim—and you can claim more than your business income. To claim business depreciation, you would file using IRS Form 4562, "Depreciation and Amortization."
For the last four tax years (plus a few months in 2017), businesses have been able to claim 100% of qualified business asset purchases. For the next four years, this rate is phasing down on the following schedule:
- 2023: 80%
- 2024: 60%
- 2025: 40%
- 2026: 20%
- No plans to extend beyond that.
Pros of Bonus Depreciation
- You can deduct depreciation even if you have a net operating loss for the year—and roll that depreciation over to future years.
- If used to pay off an equipment purchase loan, it reduces your debt.
- You can lower your business's taxable income, which lowers how much you pay in taxes and frees up more money to use throughout the tax year.
Cons of Bonus Depreciation
- You can only take 80% of the depreciation allowance of an asset purchase for 2023. This will go down as the years go on until the program is eliminated.
- Record keeping is more complicated than straight-line depreciation, where you allocate the cost of a business asset evenly over its useful life.
- Depreciation lowers the "book value" of your assets, i.e., how the asset is represented on your balance sheet. In turn, this lowers your business's collateral value and may make it more difficult to secure lending in the future.
- Taking early depreciation leads to greater tax liabilities in the future, as you can no longer claim that depreciation to reduce taxes.
- You have to take depreciation on all assets of the same type.
How Does the Section 179 Tax Deduction Work?
Section 179 can also provide a huge tax break, allowing businesses to deduct the cost of qualifying assets as an expense in the year of purchase rather than depreciating them over several years.
To claim this deduction, businesses must meet specific criteria, including the type of assets and their use in the business.
Here are some of the pros and cons:
Pros of Section 179
- You can claim 100% of the depreciation allowance of an asset purchase.
- You can apply Section 179 to whichever qualifying assets you want (up to the threshold limits).
- Simplifies your record keeping, especially if you can claim everything upfront.
Cons of Section 179
- Taking an early tax deduction limits the deductions you can take in the future.
- If you exceed the annual investment limit ($2,890,000 in 2023), you get a smaller deduction.
- You can't claim depreciation in excess of your business income, though unused depreciation may be rolled over to future years. This makes the process more complicated than regular depreciation.
- May not be applicable to state taxes, depending on your state's rules (California, for example, doesn't allow for it).
Frequently Asked Questions
Taxes are complicated. Here are some quick answers to the most frequently asked questions about taking bonus depreciation and Section 179 deductions.
Are Section 179 and bonus depreciation the same?
No, Section 179 and bonus depreciation differ. Both let businesses deduct asset costs, but with distinct rules and limits. Section 179 deducts a set dollar amount (up to limits or taxable income), while bonus depreciation deducts a percentage (80% in 2023) and can exceed taxable income.
Can I take bonus depreciation and not Section 179?
Yes, you can choose to take bonus depreciation without using Section 179. These are separate deductions, and you have the flexibility to use one or both, depending on your specific tax circumstances and eligible assets. Be sure to work with a tax planner to determine your best option.
What is the difference between bonus depreciation and Section 179 for vehicles?
To write off a vehicle, you can use Section 179 for a fixed amount deduction on new or used purchases (vehicle over 6,000 lbs). Bonus depreciation deducts a percentage without limits but applies to all eligible vehicles bought that year (also over 6,000 lbs). Section 179 offers flexibility but caps year-one deduction.
Is it better to take Section 179 or bonus depreciation for equipment?
Small to mid-sized businesses might favor Section 179 due to its straightforward deduction, while larger firms with significant asset purchases might lean towards bonus depreciation. Always consult with a tax professional to determine the best choice for your specific situation.
What are the requirements for bonus depreciation?
To claim bonus depreciation, your asset must generally have a recovery period of 20 years or less and meet other criteria, like being a new or previously owned piece of essential business equipment. It's important to check the current tax laws (they change often) and consult with a tax professional for specific eligibility and percentage deductions.
What are the requirements for Section 179?
To claim the 179 deduction, your business property must be eligible property, acquired for business purposes, and purchased outright or with qualified financing. Eligible property includes machines, vehicles, office equipment, and more.
Can I use bonus depreciation or Section 179 for improvements to a rental property?
No, you cannot. Rental property improvements are subject to standard MACRS methods of depreciation.
Use the Tools in your Business Toolbox to Save Money
Section 179 and bonus depreciation are two tools in your business toolbox. If your business is on the smaller side, or you're just getting started, Section 179 is like that trusty hammer—straightforward and effective.
But if you're a bigger player with lots of asset purchases, then bonus depreciation is your power drill, ready to handle the heavy-duty stuff. But remember, just like any project, it's always good to get a second opinion.
So, touch base with your tax guru to see which tool fits best for your business. After all, it's all about working smarter, not harder, right?