Being able to depreciate your equipment at 100% in one tax year under the federal bonus depreciation rules starts to phase out in 2023.
It drops to 80% this year and declines incrementally by 20% a year until hitting zero in 2027.
To explain what all that means, Dan Furman, vice president of strategy for Crest Capital, appears on this episode of The Dirt.
Furman explains the difference between bonus depreciation and Section 179 and what contractors need to know about the two when handling their newly purchased equipment at tax time. He also offers some helpful tax tips for contractors as well as gives his views on whether bonus depreciation will come back.
So if you’re planning to try to take advantage of federal tax benefits for purchasing equipment, check out the latest episode of The Dirt.
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In This Episode:
00:00 - Bonus Depreciation Phase-Out: What That Means for Contractors
00:34 - What’s Different About Bonus Depreciation and Section 179?
06:46 - Section 179 and Bonus Depreciation: What’s Best for Different-Size Companies?
08:02 - What Does the Bonus Depreciation Phase-Out Look Like?
10:37 - Will Bonus Depreciation Come Back?
12:45 - Advice for Contractors for 2023 Taxes
15:03 - Final Thoughts
Bryan Furnace (00:00):
Today, we're here to talk about everyone's favorite subject. We're here to talk about taxes because the way you'd depreciate your equipment is about to change. We are losing the bonus depreciation schedule that the IRS has been offering contractors for a while now. But what does that mean, and what does that look like? I'm not a tax expert, but Dan Furman is, and we're going to ask him some questions about what this means for contractors as they go to do their taxes this year.
From a guy who knows nothing about taxes and all of the shenanigans that go along with it, is bonus depreciation and Section 179 the same thing?
Dan Furman (00:41):
That's a really good question because they're very similar and they're often talked about together, but they are different. There's a couple of key differences. First, I'll tell you how they're similar. They are both accelerated depreciation schedules. Meaning you buy a piece of equipment, normally you would depreciate it over a certain number of years. Section 179 and bonus depreciation both allow you to take a much larger chunk of that this year. And for the last several years, bonus depreciation was set at 100%, meaning you could take the entire purchase price. That's where they're the same. They're both accelerated depreciation schedule.
They can also be used together. A lot of times, bonus depreciation will be used after you reach Section 179's limit, and that'll segue me into their first difference. Section 179 has a limit. There's a limit to the deduction amount. This year, it's set at $1,160,000. And there's a total equipment spend, too, and this year it's $2,890,000. Once you hit that limit, your Section 179 deduction gets reduced on a dollar-for-dollar bases. In other words, if you spend a little over $4 million in equipment this year, you don't get a Section 179 deduction.
Bonus depreciation has no limit. You could spend as much as you want on equipment and you could depreciate it all, right up to the bonus depreciation, the percentage, which, like I said, the last few years, it was set at 100%. And now, it's starting to be reduced, which is why we're talking today, because bonus depreciation is starting to go away. The first difference is their limitation. The second difference are the equipment type, and this isn't that big of a difference. Both Section 179 and bonus depreciation can be used on virtually any type of equipment of business buy, any type of tangible equipment, and even software and such, even certain software and such.
However, Section 179 can also be used on certain building improvement, like a fire system, HVAC, an alarm system, security, that sort of thing, where bonus depreciation cannot. That's the only difference really in equipment type. They both can be used on new and new-to-you equipment, so they can be used on used equipment also.
Bryan Furnace (03:12):
The real hit to contractors and the real impact they're going to see is all of these guys that run to the dealership at the end of the year to make up for that extra tax money that's going to go to Mr. Sam there. The ability to do that to the extent that they have in the past is beginning the process of going away.
Dan Furman (03:27):
Yeah, it's going to go away. Although the guy going to the dealership at the end of the year, you can use Section 179 and not bonus depreciation. But yeah, bonus depreciation is starting to go away. The big difference between the two of them, besides no limitations on bonus depreciation, is the flexibility in how they're used. Section 179, you can pick and choose what you want to use it on. You could use it on this piece of equipment and not that piece of equipment if you want. Bonus depreciation is a little more rigid.
Bonus depreciation, it follows the MACRS table, M-A-C-R-S. That's what the IRS uses to determine depreciation and the useful life of any piece of equipment. Pretty much everything you can buy is listed on the MACRS table. Most items are between three and seven years. But bonus depreciation, because everything is listed on the MACRS table, if you want to tank an item for bonus depreciation, you have to take every item in that asset plan. That sounds complicated, it's not.
What that means is, let's say you buy five backhoes, a company buys five backhoes this year. With Section 179, they can depreciate three of them this year. They can claim three of them and save the other two for yearly depreciation. With bonus depreciation, you cannot. If you claim one of them, you got to claim all five, and that's with every asset within that class. If you buy a backhoe and a bulldozer and they're both listed at five years on the MACRS table, if you want one, you've got to take them both with bonus depreciation. Every asset in that class has to be taken. Section 179 is a little more flexible in how you use it. You can pick and shoot.
Now, like I said before, you can use bonus depreciation after Section 179 is used up. Let's say, you buy an awful lot of equipment this year. You can use bonus depreciation once Section 179 is used up. But again, you have to keep that MACRS table limitation in mind, which is where your accountant is going to come in and help you out with that. He or she will say, "All right, these things over here, we can claim on Section 179, and these things over here, because we have to claim them all, we'll use bonus depreciation for."
The last difference between the two is income and profitability. Section 179 can only be used on taxable income. In other words, you got to make a profit to use Section 179. If there is no taxable income, you don't get to use Section 179. Additionally, you cannot use Section 179 to create a loss. Bonus depreciation is different there. You can use bonus depreciation. No matter what your profitability is, you can still use it. You can also use bonus depreciation to create a loss.
Now, nobody really wants to create a loss, but some years, maybe that is a viable strategy depending on your company, depending on what's going on. But keep in mind, yes, you can use bonus depreciation to create a loss. Those are the big differences between the two programs.
Bryan Furnace (06:46):
In my ignorance, it sounds to me like primarily, it's going to be a lot of your larger contractors that are doing two million plus in equipment purchases that this is really going to impact. But for the most part, your smaller contractors are going to stick to the Section 179.
Dan Furman (07:04):
Absolutely correct. Most companies who are buying one or two pieces of equipment this year, if they're looking to expense it, they're going to take a Section 179. There'd be no reason to use bonus depreciation. I don't want to go too deep into that because I'm sure there's an accountant out there that says, "Whoa. Whoa. Whoa. Whoa, wait a minute. What about this?"
Bryan Furnace (07:25):
This is the internet. That's all you're going to get in the comments.
Dan Furman (07:28):
Yeah, exactly. There'll be somebody out there who says, "Well, wait a minute," and maybe something that I'm not aware of, little accounting things. But for the most part, you are correct. You're going to use Section 179.
One other thing though, and a lot of contractors and business owners across all industries, they might not know exactly how their accountant is expensing equipment. This year, they may want to ask, "Have you been using bonus depreciation?" I'm sure the accountant knows it's going away, but just something to be aware of.
Bryan Furnace (08:02):
For the bigger guys, I'm assuming the IRS is not just going to do a full stop this year on bonus depreciation no more. I'm sure there's some sort of a phase out program.
Dan Furman (08:12):
Bryan Furnace (08:12):
What can these larger contractors expect over the next couple of years as this phases out?
Dan Furman (09:36):
In 2017, they made bonus depreciation 100%, where you could expense a 100% of an item cost. And it's been that way for the last five years. However, when the Tax Cuts and Jobs Act came out in 2017, that's of course this, built into that was a phase out. For this year, 2023, it's no longer a 100%. It's now 80%.
Now, you don't lose that 20% that's left over. You don't lose it. You just can't take it all this year. You get 80% this year, and the other 20% is factored over the life of the equipment from the MACRS table. This year, it's 80%. Next year, it's 60%. In 2025, it's 40%. 20% in 2026. And then it's gone in 2027. It's going to be phased out 20% a year now until it's gone in 2027.
Bryan Furnace (10:36):
Just out of curiosity, is this a program that we could foresee coming back down the road? Or is this something that once they phase it out, it's pretty well going to be done?
Dan Furman (10:45):
Well, that's the million-dollar question. I do feel like it will come back. The reason why I say that is, years ago, Section 179, there was this yearly dance with Section 179. Is it going to come back next year? Is it going to come back next year? And every year, without fail, it came back, until it was made a permanent part of the tax code. Bonus depreciation, I feel like hopefully in a few years, they will bring it back. That said, right now, we're in a very weird economy right now.
Bryan Furnace (11:19):
Dan Furman (11:20):
We've been hearing about a recession for a year now. We've been hearing about it. But then every two months, the Fed says, "Oh my God, the economy's too strong. We got to raise rates again. And inflation's too high. We're going to raise rates again." I would say, maybe when that all settles in another year or two, they may take another look at bonus depreciation and maybe bring it back to previous levels. However, for this year or next year, and probably even the year after, when it goes down to 40% in '25, that's probably going to stay.
Bryan Furnace (11:55):
Dan Furman (11:56):
My gut feeling tells me that it's probably going to stay, but my hope is they will bring it back. I know we're big fans of Section 179, bonus depreciation. Whatever help any business can get tax-wise, we're big fans of all that, so we're hoping it comes back.
Bryan Furnace (12:14):
It does strike me that this seems like yet another kind of fiduciary tool that they can use to either tighten up or loosen on the monetary front, and help the economy along.
Dan Furman (12:23):
Yeah. When you help businesses buy equipment and invest in themselves, you're helping everybody.
Bryan Furnace (12:29):
Dan Furman (12:29):
That means they can do more work. They hire more people. The people who make the equipment, they're selling equipment. Then, everybody's happy. Anything the government can do to help businesses tax-wise, we're in favor of.
Bryan Furnace (12:41):
Dan Furman (12:43):
I would like to see it come back. I hope it does.
Bryan Furnace (12:45):
My final question for you is, as we start the phase out, any tips that you have for contractors to help with their balance sheets as this slowly marches itself down to where you're not able to take those big depreciation tax breaks?
Dan Furman (12:56):
Well, first of all, if you were going to use bonus depreciation this year, I would say probably still use because 80% is still a pretty good number.
Bryan Furnace (13:07):
Dan Furman (13:07):
Like I said, you don't lose that extra 20%. You just have to do it over a few more years. But the 80% is still a pretty good number. If you were planning on a big purchase next year, like next year, we're going to retool the fleet, we were going to upgrade in 2024, maybe you bump that to 2023 and take advantage of that 80% this year and not the 60% that's going to be available to you next year. Maybe you bump it to 2023. And by the way, rates are probably going to stay high for the next year or two. That might be a good idea anyway. But if you were going to do a big purchase and use bonus depreciation either next year or the year after, because companies think about this a few years in advance, maybe you push that up to this year, if that makes sense here.
The other thing they can do is use Section 179. But like we talked about earlier, a lot of your smaller contractors and companies would probably do that anyway. For a lot of them, this won't affect them. It's going to be bigger guys who are buying a few million dollars worth of equipment, but you can still use Section 179 and then use the 80% bonus depreciation on the rest of the stuff you bought. You could do that also. I would say, if anybody's out there listening and they buy, let's say, more than a million dollars worth of equipment, or really any amount, be in touch with your accountant and talk about this and make a plan as to if you were going to buy more stuff next year. The accountant can guide you there.
Bryan Furnace (14:40):
Well, Dan, thank you so much. This has been super helpful, and I feel like I at least have a basic understanding of what's going on now.
Dan Furman (14:47):
Yeah, I hope I made it easy to understand it.
Bryan Furnace (14:49):
Absolutely. It was presented in a way that at least now, I have a basic understanding. But then it further gives you a job because I'm still going to continue to bring you all of my tax stuff, because I still have no idea what's going on.
Dan Furman (15:01):
Bryan Furnace (15:02):
Well, thank you, again, for Dan, taking the time to explain this whole tax situation to us. I know me, for one, I get confused around tax season. I pay someone to take care of this stuff because it's massively overly complicated. So hopefully, this gives you a little bit more clarity as you go into doing your taxes this season. As always, thanks for watching. Hope it helps. We'll catch you on the next episode of The Dirt.