Three Ways to Deduct the Cost of Business Property
Under current law, taxpayers have a variety of options for deducting some or all of the cost of property used in business rather than depreciating it over a period of years. Here’s a quick overview of three of them:
De Minimis Expensing Safe Harbor
Taxpayers with “applicable financial statements” (such as a certified audited financial statement) can deduct up to $5,000 per invoice or item for certain tangible property costs to the extent they deduct them for financial reporting or bookkeeping purposes. Those without applicable financial statements can deduct up to $2,500. Certain exceptions apply.
This safe harbor avoids the need to determine whether low-cost items are deductible or must be capitalized, as well as the need to depreciate large numbers of small-dollar capital asset purchases. It does not, however, preclude the deduction of higher-cost items if they’re otherwise deductible. Taxpayers who make the election must take the deduction for all qualifying property within the chosen threshold.
Sec. 179 Expensing
Sec. 179 allows taxpayers to deduct, rather than depreciate, up to $1,000,000 in costs of qualifying tangible property. The deduction is phased out on a dollar-for-dollar basis to the extent Sec. 179 property exceeds a $2.5 million “investment ceiling.” Property eligible for expensing generally includes most depreciable property, including computer software (subject to special rules), other than buildings and certain real property. Certain exceptions and limitations apply.
Taxpayers are permitted to deduct up to 100 percent of the cost of eligible property acquired and placed in service after 2017 and before 2023. Starting in 2023, bonus depreciation is reduced by 20 percent each year and eliminated after 2026. Bonus depreciation is taken with respect to a particular property after any Sec. 179 deduction and before regular depreciation.
Property that currently qualifies for bonus depreciation includes both new and used tangible property with a recovery period of no more than 20 years, as well as water utility property and off-the-shelf computer software. Before 2018, certain building improvements also qualified for bonus depreciation, but in what appears to be a legislative oversight, the Tax Cuts and Jobs Act of 2017 eliminated that option. It is hoped that Congress will restore bonus depreciation for this “qualified improvement property.”
Special rules apply to property a taxpayer manufactures, constructs, or produces for its own use: long-production-period property and aircraft; passenger automobiles; and certain other types of property. Taxpayers can elect out of bonus depreciation for any class of property in a given tax year. Taxpayers and their advisors should work together to take advantage of these options in the most effective manner. All three tax breaks can be used in the same year, but they can’t be applied to the same costs.