2023 Tax Alert - What does bonus depreciation’s 2023 phaseout mean for construction companies and builders?

By Dan Furman

Bonus depreciation has long been a favorite of small and midsized companies, especially those who make large-ticket purchases of new or used equipment.

This is because it allows them to accelerate the depreciation of purchased equipment to the current tax year, and take it as a tax deduction.  

Thanks to 2017’s Tax Cut and Jobs Act, 100% of an item’s cost could be depreciated in the year it was purchased, which allowed for a full-price tax deduction.

But also written into that same law was a planned phaseout, which begins in the 2023 tax year. This phaseout will affect companies that use bonus depreciation annually to pay less tax. 

Since almost all companies are keenly interested in reducing their tax obligations, this article will review the ins and outs of bonus depreciation and the phaseout. We’ll also discuss how it differs from Section 179, and offer a few strategies for companies who previously relied upon bonus depreciation.   

What is Bonus Depreciation?

Bonus depreciation first became available in 2002 as an incentive for companies to invest in themselves and purchase equipment. 

All business equipment has a depreciation schedule associated with it (the MACRS depreciation schedule.) 

For example, most pieces of heavy equipment are on a five-to-seven-year schedule. We’ll use five to make it simple.

In this case, under normal depreciation, a company would depreciate the asset 20% a year for five years. But under bonus depreciation, a company can take a higher percentage during the first year. 

As stated, since 2017, that “higher percentage” was 100%. Using bonus depreciation, a company could deduct the full price the year they purchased it, a very attractive tax-reducing incentive. But that’s changing in the 2023 tax year.

For purchases made this year, it’s dropping to 80%. It will then continue to drop (60% in 2024, 40% in 2025, 20% in 2026) until it’s completely phased out in 2027.

Many people also confuse bonus depreciation with Section 179. That’s because they are actually quite similar. However, there are some key differences, which we’ll go over next.

Bonus Depreciation and Section 179 – What’s the Difference?  

Bonus depreciation and Section 179 are both accelerated depreciation schedules and are typically mentioned together. In addition, they can both be used in the same year (on different purchased equipment, of course). But there are some very important differences: 

They Have Different Limits on Both Spending and Deduction Amount

Section 179 has built-in limits on both the total deduction taken, and the total amount spent on equipment.

For 2023 purchases, Section 179 allows a total deduction of $1,160,000. There is also a $2,890,000 limit on total equipment purchases.

Once that number is reached, the deduction is reduced on a dollar-for-dollar basis, until it disappears. 

Put simply, if a company spends $4,050,000 on equipment this year, they cannot use Section 179 at all.  

Bonus depreciation has no limits. Companies can spend as much as they want on equipment, and the entire spend is eligible for accelerated depreciation and write-off.

In fact, companies that hit the Section 179 limit will often switch over to bonus depreciation for the rest. 

Qualifying Equipment Differences

Honestly, 99% of tangible business equipment will qualify for both Section 179 and bonus depreciation. Either can be used on machinery, heavy equipment, vehicles, office equipment, IT equipment, tools, POS systems, signage, material handling equipment, many types of software, and a lot more. 

The biggest difference is Section 179 can also be used for certain building improvements, such as a security system, the HVAC system, a fire suppression system, and a few others. 

Bonus depreciation cannot be used for those things.   

Flexibility in Use

Section 179 is quite flexible and allows companies to choose which purchases to include in any accelerated depreciation.

Bonus depreciation is more of an “all or nothing” use, broken down by the previously mentioned MACRS depreciation class/expected life. If a company wishes to depreciate a purchase, all same-year purchases of that class must be declared. 

For example, let’s say a company purchases four pieces of equipment – a backhoe, a scissor lift, an articulated boom lift, and a heavy-duty pickup. It can use Section 179 on any number of them and save the remaining for yearly depreciation. So they can take a full Section 179 deduction this year on the two lifts and the pickup, while saving the backhoe to depreciate yearly.  

That option is not open to them if they choose bonus depreciation. Instead, if they are all in the same MACRS class (very likely), they must declare all four, plus any other purchases in that same MACRS class. This can dramatically reduce future depreciation. 

Showing (or Creating) a Loss

A Section 179 deduction can only be used on taxable income – if there is no income to tax (i.e., the company had a loss), Section 179 cannot be used. 

In addition, Section 179 cannot create a loss. 

Bonus depreciation has no such restriction and can be used in any fiscal event – profit, loss, or break even.

It can also be used to create a loss.

This can act as a hedge against unforeseen events – no matter what happens profitability-wise, bonus depreciation ensures a company will still get its deduction. 

How Will the Phaseout Affect Your Business? 

Companies planning to use bonus depreciation in 2023 will see their first-year depreciation reduced from 100% to 80%.

Note that the remaining 20% is not lost – it can still be depreciated over the next several years. But that year-one deduction will be smaller than last year. 

What Should Affected Companies Do? 

There are a few options available to affected companies:

For 2023, the best option may be to take the 80% (still a large deduction) and depreciate the remaining 20% over the next few years. Nothing is lost – it’s simply spread out further. 

This gets murkier if a company has future year purchases planned. For example, a company already planning large 2024 purchases might balk at the 60% number available then. Perhaps moving those purchases to 2023 when it’s 80% makes more sense.

Companies can also simply use Section 179 instead (assuming they will be profitable this year), and if the limits are reached, use the 80% bonus depreciation on the rest. This should mitigate some of the sting.  

Wrapping Up 

The 2023 bonus depreciation phaseout will likely affect companies relying on it for a tax deduction. But there are practical approaches companies can use to mitigate the smaller percentages. Whether it’s acting sooner on future purchases to take advantage of 2023’s 80% rate, or turning to Section 179 instead, companies should be aware of bonus depreciation’s phaseout and use all tax deductions available to them. 

All views expressed in this article are those of the author and do not necessarily represent the policy or position of Crest Capital and its affiliates. These views are also opinions, not professional advice – always speak to your accountant or tax professional before engaging in any financial contract or tax matter.

 

Dan Furman is vice president of strategy at Crest Capital, which provides small and mid-sized companies financing for new and used equipment, vehicles, and software, as well as offering equipment sellers a simple and risk-free financing program. Visit them at
www.crestcapital.com