Tax Strategy Involving Section 179 Depreciation Deductions

Internal Revenue Code Section 179 potentially allows significant first-year depreciation deductions when your business places qualifying assets into service. You generally want to maximize current year depreciation write-offs for newly acquired business assets. However, the Sec. 179 rules change annually due to inflation adjustments, and limitations may apply. You’ll also need to factor available first-year bonus depreciation into your decisions. Here’s what you need to know to maximize these tax breaks.

The Basics

Most tangible depreciable business assets qualify for the first-year Sec. 179 deduction privilege. Examples include:

• Equipment,
• Furniture and fixtures,
• Computer hardware,
• Vehicles (subject to limits), and
• Most off-the-shelf software.

For tax years beginning in 2024, the inflation-adjusted maximum Sec. 179 deduction is $1.22 million. The deduction begins to phase out when 2024 qualified asset additions exceed $3.05 million.

For tax years beginning in 2025, the same deduction will max out at $1.25 million and begin to phase out when 2025 qualified asset additions exceed $3.13 million.

If you place in service assets that qualify for the Sec. 179 deduction and their total cost exceeds the annual inflation-adjusted phaseout threshold, your maximum allowable deduction is reduced by the excess. For example, if your business places $3.5 million of qualifying assets in service during the tax year beginning in 2024, this will impact your deduction. The excess over the phaseout threshold is $450,000 ($3.5 million minus $3.05 million). Your maximum allowable Sec. 179 deduction for the tax year would be reduced to $770,000 ($1.22 million minus $450,000).

Important: As explained later, 60% first-year bonus depreciation is available for eligible assets placed in service in calendar year 2024. That can make up most of the difference caused by the Sec. 179 deduction phaseout rule.

Other Rules and Restrictions

Under a special rule, the maximum Sec. 179 deduction for a heavy vehicle that’s classified as an SUV for tax purposes is $30,500 if it’s placed in service in a tax year beginning in 2024. A heavy SUV is one with a manufacturer’s gross vehicle weight rating (GVWR) above 6,000 pounds. For a tax year beginning in 2025, the same deduction will max out at $31,300.

Depreciable real property generally doesn’t qualify for the Sec. 179 deduction privilege unless it’s qualified improvement property (QIP). QIP includes improvements to the interior of a nonresidential building made after the date the building is placed in service. However, any costs to expand the building, or for elevators, escalators and structural framework, don’t qualify as QIP. Sec. 179 deductions are also allowed for nonresidential building roofs, HVAC equipment, fire protection systems and security systems if they’re added after the building is placed in service.

Business Income Limitation

Sec. 179 deductions are disallowed to the extent that they would result in an overall business taxable loss. Specifically, your deduction is limited to your aggregate taxable income derived from the active conduct of all businesses. Such income includes:

• Wages, salaries, tips, and other compensation,
• Your share of proprietorship, partnership, limited liability company or S corporation net income (or loss),
• Sec. 1231 gains (or losses) from selling business assets,
• Depreciation recapture income from selling depreciable business assets, and
• Interest earned from business working capital.

If you’re active in a rental activity, you may be able to count the net rental income. Don’t count hobby income. If you file joint returns with your spouse, count both your business income and your spouse’s business income (if any).

If your Sec. 179 deduction is reduced by the business income limitation, you can carry forward the disallowed amount or potentially depreciate the disallowed amount under the first-year bonus depreciation rules. Bonus depreciation isn’t subject to any dollar limits or phaseouts (see below).

Sec. 179 Deductions vs. First-Year Bonus Depreciation

Most tangible depreciable business assets (including off-the-shelf software and QIP) also qualify for a separate tax break: the first-year bonus depreciation privilege. For qualifying assets placed in service in 2024, the first-year bonus depreciation percentage is 60% (down from 80% for 2023 and 100% for 2022). For qualifying assets placed in service in 2025, the first-year bonus depreciation percentage drops to 40%.

These percentage cutbacks are delayed by one year for certain assets with longer production periods. For example, the 80% bonus depreciation rate applies to long-production-period property placed in service in 2024 and the 60% rate will apply to long-production-period property placed in service in 2025.

Unlike Sec. 179 deductions, first-year bonus depreciation deductions aren’t subject to any complicated limitations. The current tax-saving strategy is as follows:

1. Write off as much of the cost of qualifying asset additions as you can with the Sec. 179 deduction privilege, and
2. Claim as much first-year bonus depreciation as you can for any remaining asset additions.

For instance, suppose Joe’s calendar-tax-year C corporation places in service $500,000 of assets in 2024 that qualify for both the Sec. 179 deduction privilege and first-year bonus depreciation. However, due to the taxable income limitation, his company’s Sec. 179 deduction is limited to only $300,000, which can be claimed on the corporation’s federal income tax return. The company can then deduct 60% of the remaining $200,000 under the first-year bonus depreciation privilege ($500,000 minus $300,000). So, the company’s write-offs for the year would include 1) a Sec. 179 deduction of $300,000, and 2) $120,000 of bonus depreciation (60% of $200,000). That’s a grand total of $420,000 in write-offs for 2024, leaving only $80,000 left to depreciate in future tax years. (Note: If the business income limitation didn’t apply, Joe’s business could have written off the entire amount under the Sec. 179 deduction rules, because his company’s asset additions are below the applicable deduction phaseout threshold.)

Important: Claiming significant first-year depreciation deductions may not be the right strategy for every taxpayer. Depreciation deductions could be more valuable in the future, for example, if you expect to move into a higher tax bracket. Plus, big first-year depreciation deductions may reduce the tax-saving benefits of other tax breaks, such as the qualified business income deduction for owners of pass-through entities.

Maximize the Benefits, Minimize Your Taxes

As year end approaches, it’s important to evaluate your business tax situation. There’s a lot to consider, including coordinating first-year Sec. 179 deductions with first-year bonus depreciation deductions. Navigating the rules is especially complicated for owners of pass-through entities.

Warning: Two-Tiered Rules for Pass-Through Entities

The Section 179 limitation rules are tricky when assets are owned by a pass-through entity, such as a limited liability company, partnership or S corporation. That’s because the limitation rules are applied at both the entity level and the owner level. Your tax advisor can provide details on how the Sec. 179 deduction limitation rules work for pass-through entities and their owners.

If your business needs new equipment, vehicles or other qualifying assets, you might decide to buy those assets and place them in service before the end of the current tax year to help lower your tax bill. If your business’s qualifying asset additions already exceed the Sec. 179 deduction phaseout threshold for the current year, you might want to wait until next year. But beware, the bonus depreciation percentage is currently scheduled to drop to only 40% for most qualifying assets placed in service in 2025. Then again, it’s also possible that 100% first-year bonus depreciation will be restored by future legislation. Contact your tax advisor to help devise the optimal tax strategy for your situation and to stay atop the latest tax law developments.

Copyright 2024

This article appeared in Walz Group’s November 11, 2024 issue of The Bottom Line e-newsletter, produced by TopLine Content Marketing. This content is for informational purposes only.