Last December’s Tax Cuts and Jobs Act (TCJA) not only slashed tax rates, it also enacted rules that allow businesses to treat as an expense and immediately write off more—including 100 percent temporary expensing for certain assets. This means adding needed equipment, vehicles or even a new shop building is now a lot more affordable.
In addition to the increased write-offs available to help offset the cost of acquiring needed business assets, changing depreciation limits on so-called listed cars and personal-use property also means the new law contains some potential pitfalls.
Writing off the cost of much of newly acquired property in the year it is placed in service has long been possible under the Section 179, first-year expensing rules. The TCJA increased the maximum deduction for Section 179 property while also ramping up the other major write-off, so-called bonus depreciation, raising it from 50 percent to 100 percent for property placed in service before 2023.
Section 179 of the tax law is an incentive designed by lawmakers to encourage businesses to buy equipment and invest in their operations. Essentially, Section 179 allows businesses to deduct the full purchase price of qualifying equipment and/or software purchased during the tax year. In other words, if you buy qualifying equipment, you can deduct the full cost as an immediate expense.
Under U.S. tax rules—and the new law—a specialty fabrics professional can choose to treat the cost of any Section 179 property as a business expense and deduct it in the year the property is placed in service. The new law increased the maximum amount that can be deducted from $500,000 to $1 million and the phase-out threshold from $2 million to $2.5 million.
Also, the TCJA expanded the definition of Section 179 property to include improvements made to non-residential real property after it is placed in service—meaning, improvements to a building’s interior. However, improvement costs don’t qualify if they:
* enlarge the building
* add an elevator or escalator
* alter the internal structural framework of the building.
Viva la difference
Unfortunately, the new law keeps the general 39-year recovery period for non-residential real property such as shops, offices or warehouses. Qualified leasehold improvement property, restaurant property and retail improvement property are no longer separately defined and given a special 15-year recovery period under the new law.
The most important difference between the Section 179 first-year expensing allowance and bonus depreciation has long been that both new and used equipment qualified for the Section 179 deduction. Today, however, bonus depreciation includes used equipment.
The Section 179 deduction is usually taken first, followed by the bonus depreciation. Generally, bonus depreciation is useful to very large businesses spending more than the Section 179 spending cap (currently $2.5 million) on new capital equipment. Businesses with a net loss can still deduct some of the newly acquired cost and carry the loss forward for use in later, more profitable tax years.
That “bonus” write-off
For all property acquired by the fabrication business and placed in service after September 27, 2017, the TCJA requires a full 100 percent deduction of the cost of eligible new and used property—unless the business owner chooses not to claim the depreciation write-off for any class of property.
While the new law eliminates the requirement that the original use of the qualified property begin with the fabrication business, as long as it had not previously used the acquired property and the property was not acquired from a related property, it will qualify. However, the 100 percent deduction phases out at a rate of 20 percent per year beginning with the 2023 tax year (and extended by one year for certain long-production-period property and aircraft).
Paybacks are expensive
Although Section 179 is a write-off rather than a depreciation deduction, many specialty fabrics professionals feel that no records must be kept. The write-off is, however, comparable to claiming all of the depreciation allowed in one year. Should the business asset or property be sold or otherwise disposed of, a portion, or all, of that write-off may have to be recaptured or paid back. The best approach is to treat all qualifying purchases like fixed asset acquisitions, retaining all documentation for at least four years after the property or assets are disposed of.
And, above all, don’t forget about the property or assets being replaced. The sale of business equipment or property can generate a short-term loss. A sale that produces a gain generates ordinary income up to the recapture of depreciation, after which it produces a capital gain—if held long enough.
What happens when equipment, vehicles, fixtures or other business assets or property are no longer useful to the operation or replaced with Section 179 or bonus depreciation acquisitions? Many specialty fabrics businesses can claim an “abandonment” loss.
Of course, for the IRS to accept a bona fide abandonment write-off of any business asset, there must be an actual intent to abandon it. There must also be an “overt” act to abandon the asset. Not too surprisingly, this two-pronged test can frequently be difficult to document.
Cars and personal use property
Several years ago, Section 179 became known as the “SUV tax loophole” because so many businesses were writing off the purchase of what were then qualifying vehicles. While that particular benefit of Section 179 has been severely reduced, special rules—and limits—remain on deductions for cars and personal use property.
New limits on the write-off for the cost of so-called luxury automobiles and personal use property were included in the TCJA. For passenger automobiles and light trucks placed in service after December 31, 2017, where the additional first-year depreciation deduction is not claimed, the maximum amount of allowable depreciation is increased to $10,000 for the year in which the vehicle is placed in service, $16,000 for the second year, $9,600 for the third year and $5,760 for the fourth and later years in the recovery period.
For passenger automobiles placed in service after 2018, these dollar limits are indexed for inflation. And for those eligible for bonus first-year depreciation, the TCJA retained the $8,000 limit for additional first-year depreciation for passenger automobiles. In 2018 the maximum first-year write-off is $18,000.
Similar rules apply not only to passenger automobiles, but to any property used as a means of transportation as well as for entertainment, recreation or amusement. Computers and peripheral equipment have been removed from the definition of listed property and are no longer subject to the increased substantiation requirements.
When it comes to leased vehicles used in the fabrication business, a deduction is permitted for the part of the lease payment that represents its business use. If it’s used 100 percent of the time for business, the full lease cost is deductible.
So that vehicle leases don’t escape the luxury vehicle limits, a portion of the lease payment must be included in income each year to partially offset the lease deduction. That amount varies with the initial fair market value of the leased vehicle and the year of the lease. The amount is also adjusted for inflation each year.
Let the write-offs roll
Lawmakers are pretty strict when it comes to allowing deductions. The cost of starting a business, for example, can’t be deducted—because there is no business. Just as there can be no business until the operation “opens its doors” for the first time, buying new equipment or other business assets doesn’t mean that the cost can be immediately deducted or written off—they must first be “placed in service.”
Determining the date that property is placed in service for depreciation or other write-off purposes requires looking at factors such as the property’s assigned function and when the property is in a condition or state of readiness and available for specifically assigned functions.
Keep in mind that buying may not always be the best option. Expensing drops the book value or basis to zero. If the asset is sold, any amount up to the purchase price will be ordinary, fully taxable income. Spreading the expense through depreciation deductions will reduce taxable income down the road when the business may be more profitable and have higher tax bills. Another situation where expensing may not be the most economic route is when the asset might be sold in the near future and/or the asset is one that holds its value.
The changes in the cost recovery rules are already having a significant impact on whether newly acquired equipment or business property should be depreciated or expensed, and whether or not to choose bonus depreciation for any class of property. Because the new rules interact with other provisions of the law, specialty fabrics professionals should seek professional advice and assistance in planning to maximize their write-offs for business property and assets.
Mark E. Battersby writes extensively on business, financial and tax-related topics.