What is Section 179 Depreciation? Do My Purchases Qualify for Bonus Depreciation?

Investing in capital equipment continues to provide significant tax benefits for businesses. The Tax Cuts and Jobs Act of 2017 brought substantial changes to both Section 179 and bonus depreciation, and these updates are still relevant in 2024. By leveraging both of these tax provisions, companies might be able to claim deductions for up to 100% of their capital equipment expenditures.

However, to achieve this full deduction, the cost of the equipment must not exceed the phase-out limit and must fully qualify under Section 179. For costs surpassing these thresholds, bonus depreciation applies, set at 60% for 2024. Keep reading for an in-depth guide on these deductions and how they can reduce your tax liabilities this year.

Understanding Section 179

Section 179 is a tax provision that enables businesses to deduct the entire purchase cost of qualifying equipment in the year it is placed into service. This allows companies to reduce their tax liability more significantly upfront, compared to using standard depreciation methods that spread deductions over several years.

Businesses can either finance or pay in full for the qualifying equipment. However, to benefit from this accelerated depreciation, the equipment must be in use by December 31 of the relevant tax year. Due to recent extended lead times for equipment deliveries, businesses should carefully plan their purchases to meet this deadline if they want to capitalize on the deduction.

Although Section 179 has some limits on the types and amounts of equipment that qualify, the allowances are substantial, particularly for small to mid-sized businesses. These tax provisions have been in place for many years, but the changes made in 2018 were especially impactful. These changes included the ability to deduct the cost of used equipment (as long as it’s new to the buyer) and increases in the deduction limits. For tax year 2024, the IRS has raised the maximum deduction and the total amount of equipment that can qualify by approximately 5%.

Prior to the enactment of the Tax Cuts and Jobs Act (TCJA), businesses could claim a maximum Section 179 deduction of $500,000, with a phase-out starting once expenditures reached $2 million. The TCJA significantly increased these limits, raising the deduction cap to $1 million and the phase-out threshold to $2.5 million, with provisions for annual inflation adjustments. As of 2024, small and mid-sized businesses that invest less than $4.27 million annually in equipment are eligible for Section 179 deductions.

How Does Section 179 Work?

If you’re planning to take advantage of the Section 179 tax deduction in 2024, here are some easy steps to follow:

• Buy and Use the Right Items: Purchase equipment or property that qualifies for Section 179, like machinery, office furniture, computers, and software. To get the deduction for 2023 (when filing taxes in 2024), you need to start using these items between January 1, 2023, and December 31, 2023. For the deduction in 2024, make sure to use them by the end of that year. Keep all receipts related to the purchase, including installation, shipping, and setup costs.
• Record Everything: Keep detailed records and receipts of your purchases and related expenses. These records are essential for calculating your tax deduction.
• Consult a Tax Professional: Hand over all your documentation to a tax professional who will help determine how much you can deduct.
• Fill Out Tax Form 4562: You must complete IRS Form 4562 to claim the Section 179 deduction officially. This form details your business’s depreciation expenses and must be included with your tax return.
• Calculate Your Savings: Your tax professional will work out how much tax you owe for the year and apply the Section 179 deduction to reduce your taxable income.

In 2024, the Section 179 deduction has a cap of $1,220,000. However, if the total cost of your qualifying purchases exceeds $3,050,000, the deductible amount begins to decrease. Should these costs surpass $4,270,000, you won’t be eligible for the deduction at all. The items that typically qualify for this deduction include tangible assets like machinery, computers, and off-the-shelf software.

On the other hand, real estate usually does not qualify, although certain improvements to property may. Unlike regular business expenses such as rent or insurance, which are deducted gradually over time, Section 179 allows businesses to deduct the full cost of qualifying assets immediately. This immediate deduction accelerates the financial benefit, providing significant tax relief in the acquisition year.

What Is Bonus Depreciation?

Bonus Depreciation is a tax benefit that allows businesses to take a larger depreciation deduction in the first year for qualified assets, speeding up cost recovery. To qualify for bonus depreciation in 2024, your purchases must meet certain criteria:

• The property should have a useful life of 20 years or less.
• You should not have previously used it or acquired it from a related party.
• It must be placed in service during the tax year.

The TCJA of 2017 expanded this benefit, allowing businesses to immediately deduct 100% of the cost of eligible assets placed in service between September 27, 2017, and January 1, 2023. This provision was designed to stimulate capital investment.

Starting in 2023, the 100% bonus depreciation began to phase out, decreasing to 80%. For 2024, the deduction is reduced to 60%, and it will continue to drop by 20% each year—reaching 40% in 2025, 20% in 2026, and phasing out entirely by 2027 unless new legislation extends it.

Bonus depreciation is automatically applied unless a business opts out, but opting out requires an election on a timely filed tax return. This election must be made for each class of property (e.g., 3-year, 5-year), and failure to make the election could result in applying the wrong depreciation method.

In 2024, businesses should strategically plan asset acquisitions to take advantage of the 60% deduction by placing qualified property in service before year-end. By 2027, only Section 179 deductions will remain available, with specific caps tied to business income and investment limits.

How Does Bonus Depreciation Work?

Bonus depreciation is a tax incentive that allows businesses to write off a substantial portion of the purchase cost of qualified assets. To utilize this tax break, businesses must first purchase property that qualifies under the rules. This includes property with a useful life of 20 years or less, such as vehicles, furniture, equipment, fixtures, and machinery, excluding land and buildings. Improvements made to the interior of commercial buildings after they are open for business, certain computer software, and some listed properties also qualify.

Listed properties, such as vehicles and cameras, are eligible if used for business purposes at least 50% of the time. Additionally, costs associated with qualified film or television productions and live theatrical productions can also be deducted.

Once the qualified property is acquired, it must be placed in service, meaning it should be set up and used in the business’s operations. For example, if a piece of machinery is purchased in December 2023 but not installed or operational until January 2024, the bonus depreciation can only be claimed on the 2024 tax return. The final step is to claim the bonus depreciation on the tax return by writing off up to 100% of the asset’s cost on Form 4562, which is filed along with the business’s tax return. This step completes the process of taking advantage of bonus depreciation, offering significant tax relief to businesses investing in new property and equipment.

Understanding the Key Differences Between Section 179 and Bonus Depreciation

The primary distinction between Section 179 depreciation and bonus depreciation lies in their limits and flexibility. Section 179 is subject to an annual cap set by the IRS, which was $1,080,000 in 2022, and is reduced once purchases exceed the threshold of $2,700,000. In contrast, bonus depreciation does not have an annual deduction limit.

Section 179 offers more flexibility, allowing businesses to deduct any amount within the specified thresholds and to allocate those deductions across assets as they see fit. This enables businesses to decide which assets to depreciate and how much to deduct for each, allowing them to strategically manage their deductions.

On the other hand, bonus depreciation requires businesses to deduct the full bonus percentage (80% in 2023, reducing by 20% annually until phased out in 2027) for all assets within a selected class, leaving no depreciation for future years. Another key difference is that Section 179 is limited to the amount of taxable income a business has, whereas bonus depreciation can be used to create a net loss.

Although bonus depreciation can offer substantial savings, Section 179 deductions allow a company to adjust its financial outcomes more precisely. The decision of which depreciation method to use should be tailored to each company’s financial situation, considering current and future implications. Seeking advice from a tax professional can help businesses maximize their savings by developing an effective depreciation strategy.

Maximizing Tax Benefits in 2024: Combining Section 179 and Bonus Depreciation

In 2024, businesses can optimize their tax benefits by combining Section 179 and Bonus Depreciation deductions for asset acquisitions. These two deductions enhance flexibility and increase tax savings when applied together.

• Sequence of Deduction Utilization: According to IRS guidelines, companies should first apply the Section 179 deduction. As mentioned, for 2024, the Section 179 deduction cap is $1.22 million, initiating a phase-out when asset investments exceed $3.05 million. Once the cap for Section 179 is maxed out, businesses can employ Bonus Depreciation to further decrease their taxable income, allowing for up to a 60% deduction on the residual cost of eligible assets. If total equipment purchases exceed $3,050,000, the Section 179 deduction is reduced on a dollar-for-dollar basis.
• Strategies for Integration: Section 179 permits selective depreciation of assets and enables full upfront deduction of an asset’s cost within the deduction limit. Conversely, Bonus Depreciation mandates a uniform percentage deduction across all assets in a category at 60% for 2024. Businesses should prioritize Section 179 to exhaust their limit for optimal tax relief before applying Bonus Depreciation on larger expenditures.
• Eligible Assets for Deductions: Both deductions apply to various assets, including equipment, machinery, software, and enhancements to non-residential properties. Notably, Bonus Depreciation extends to land improvements, which are not eligible under Section 179. Section 179 is particularly advantageous for enterprises with modest taxable incomes, while Bonus Depreciation is beneficial in years of business losses.

Employing these deductions in tandem allows businesses to significantly lower their taxable income and secure more substantial tax savings in 2024, a year when the scope of Bonus Depreciation is set to diminish.

Example of Combining Section 179 and Bonus Depreciation

In 2024, calculating tax deductions available to a C-Corporation purchasing $3,000,000 worth of qualifying equipment involves several components. The process starts with the Section 179 deduction, which for 2024 is capped at $1,220,000. This allows businesses to deduct the full amount of their qualifying purchases up to this limit in the first year. Once the Section 179 deduction has been applied, any remaining equipment cost can benefit from additional deductions through Bonus Depreciation and standard depreciation under the Modified Accelerated Cost Recovery System (MACRS).

• Section 179 Deduction: $1,220,000 from the initial $3,000,000
• Remaining Balance after Section 179 Deduction: $1,780,000
• Bonus Depreciation at 60% on the remaining balance: $1,068,000
• Remaining balance post Bonus Depreciation: $712,000
• First-year Standard Depreciation (20% of $712,000 under 5-year MACRS): $142,400

By combining these tax strategies, the total first-year deduction for the business amounts to $2,430,400. This series of deductions dramatically lowers the corporation’s tax liability by applying the 21% corporate tax rate, leading to a tax saving of approximately $510,384. As a result, the effective cost of the equipment is reduced to $2,489,616.

Businesses use these deductions to reduce financial strain from large purchases and incentivize investment in new equipment by accelerating tax savings. However, businesses need to consult with a tax advisor to apply these deductions and ensure compliance with tax laws correctly.

Conclusion

Understanding and effectively utilizing both Section 179 and Bonus Depreciation in 2024 can provide substantial tax benefits for businesses. While Section 179 offers flexibility with an annual deduction cap, Bonus Depreciation allows for larger, more immediate deductions, especially for larger asset purchases.

Companies can significantly reduce their taxable income by strategically combining these two deductions. However, it is important to assess individual financial situations and consult with a tax professional to maximize these benefits and ensure compliance with current tax regulations.

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