Breaking the Code: Phase out of Bonus Depreciation in 2023
By: Justin Lin, Tax Associate
Act now to maximize the benefits of bonus depreciation before it phases out. Beginning in the 2023 tax year (and over the next five years), the IRS is ramping down the allowable percentage of bonus depreciation for the cost of qualifying business property.
What is Bonus Depreciation?
Bonus depreciation is an incentive designed for business owners to accelerate the depreciation process (for qualifying business expenses) by realizing an additional amount of depreciation in the first year of purchase. In prior years, this amount was 100%, meaning taxpayers could recognize all the depreciation expense in the first year of the purchase. This amount is being reduced to 80% in 2023, 60% in 2024, 40% in 2024, and 20% in 2026. Barring any legislative changes, there will be no allowable bonus depreciation starting from 2027. With this phase out, businesses have greater incentive to make qualifying capital expenditures in the near-term. While bonus depreciation may be no longer be an option in the future, businesses will still be able to take advantage of Section 179 deductions.
What is Section 179 , and how is it related?
The Section 179 deduction is another tax incentive which accelerates the depreciation process for qualifying equipment. This is different from bonus depreciation in that the deduction only applies to tangible property used in a business such as machinery, equipment, furniture, and fixtures. For 2023, the Section 179 deduction is $1,160,000, with a phase out threshold for purchases above $2,890,000 (reduced on a dollar-for-dollar basis). These limitations are currently adjusted annually for inflation.
An Example - 2023
Fortunately, taxpayers can use both deductions together – combining them while both are available to provide the greatest benefit. Per IRS regulations, Section 179 deduction must be applied first, follow by bonus depreciation (if both are applicable)
Let’s say for example, you purchase qualifying business equipment for $3,000,000 in 2023. This is $110,000 over the phase out threshold of $2,890,000 for the year – meaning your section 179 deduction is reduced $110,000 from the maximum deduction of $1,160,000 to $1,050,000. Then, your bonus depreciation deduction of 80% is based on the cost of the equipment less the section 179 deduction. 80% * ($3,000,000 - $1,050,000) = $1,560,000. Add in your standard depreciation (assuming straight line depreciation over 5 years) which is calculated by dividing your adjusted cost basis (net of section 179 and bonus depreciation) over the depreciable life of the asset ($3,000,000-$1,050,000-$1,560,000)/5=$78,000. In total, you can deduct/depreciate $2,688,000 of the equipment’s $3,000,000 value in the first year.
If you’re wondering how these benefits could impact your business tax deductions, don’t hesitate to reach out to us.
Tax Brackets - 2024 Updates
See the table below for the updates to the Tax Rates for the tax year 2024, which will be effective for taxes due in 2025.
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