In addition to the basic MACRS rules, several additional provisions affect the deprecia- tion of personal property. Congress often uses these special rules for economic stimulus or to curb perceived taxpayer abuses. The TCJA substantially modifies and extends these special rules (§179, bonus depreciation, and listed property). For many businesses, the calculation of MACRS depreciation for its personal property will become a thing of the past because of the expansion of these special rules. It is worth noting, however, that Congress did not make all of the changes permanent. For example, the changes to bonus depreciation are effective for property placed in service before January 1, 2023 with a subsequent four-year phase-out. We discuss these rules below.
Immediate Expensing (§179) Policy makers created §179 as an incentive to help small businesses purchasing new or used tangible personal property. This incentive is commonly referred to as the §179 expense or immediate expensing election.28 This pro- vision will have limited application under TCJA because bonus depreciation discussed below allows taxpayers to immediately deduct assets’ initial basis. As discussed earlier in the chapter, businesses must generally depreciate assets over the assets’ recovery pe- riods. However, under §179, businesses may elect to immediately expense up to
$1,000,000 of tangible personal property placed in service during 2018.29,30 Businesses can also use immediate expensing for off-the-shelf computer software and qualified real property.31 They may also elect to deduct less than the maximum. When businesses elect to deduct a certain amount of §179 expense, they immediately expense all or a portion of an asset’s basis or several assets’ bases. To reflect this immediate depreciation, they must reduce the basis of the asset or assets (to which they applied the §179 amount) before they compute MACRS depreciation (from the tables).
Exhibit 10-8 shows the assets Teton acquires in 2018.
LO 10-3
EXHIBIT 10-8 Teton’s 2018 Asset Acquisitions
Asset Cost Date Placed in Service
Computers & information systems $ 920,000 March 3
Delivery truck* 80,000 May 26
Machinery 1,200,000 August 15
Total $2,200,000
*Steve had used this truck personally and converted it to business use in May.
Example 10-11
What if: Assume Teton is eligible for and elects to immediately deduct $800,000 of §179 expense against the basis of the machinery acquired in 2018 (see Exhibit 10-8). (Note that Teton could have elected to deduct up to $1,000,000.) What is the amount of Teton’s current-year depreciation deduc- tion, including regular MACRS depreciation and the §179 expense on its machinery (assuming the half-year convention applies)?
(continued on page 10-18)
28Intangibles and tangible personal property that are used less than 50 percent for business and most real property are not eligible for immediate expensing.
29The maximum allowable expense under §179 is indexed for inflation beginning with years after 2018.
30These maximum amounts are per tax return. Thus, if an individual has multiple businesses with asset acquisitions, the taxpayer may only deduct up to these maximum amounts for the combined businesses.
31Qualified real property means improvements to nonresidential real property placed in service after the date the building was placed in service including roofs; heating, ventilation, and air-conditioning; fire protection and alarm systems; and security systems.
32The threshold under §179 is indexed for inflation beginning with years after 2018.
Limits on immediate expensing. The maximum amount of §179 expense a business may elect to claim for the year is subject to a phase-out limitation. Under the phase-out limitation, businesses must reduce the $1,000,000 maximum available expense dollar for dollar for the amount of tangible personal property purchased and placed in service dur- ing 2018 over a $2,500,000 threshold.32 Thus if a business places $3,500,000 ($2,500,000 threshold plus $1,000,000) or more of tangible personal property into service during 2018, its maximum available §179 expense for the year is $0. The phased-out portion of the maximum expense disappears and does not carry over to another year.
What if: Let’s assume that during 2018, Teton placed into service $2,400,000 of machinery (up from the Exhibit 10-8 amount of $1,200,000), $920,000 of computers, and an $80,000 delivery truck for a total of $3,400,000 tangible personal property placed in service for the year. What is Teton’s maximum
§179 expense after applying the phase-out limitation?
Answer: $100,000, computed as follows:
Description Amount Explanation
(1) Property placed in service in 2018 $3,400,000 Exhibit 10-8
(2) Threshold for §179 phase-out 2,500,000 2018 amount [§179(b)(2)]
(3) Phase-out of maximum §179 expense 900,000 (1) − (2) (4) Maximum §179 expense before phase-out 1,000,000 §179(b)(1) (5) Phase-out of maximum §179 expense 900,000 From (3) Maximum §179 expense after phase-out* $ 100,000 (4) − (5)
*Note that this is the maximum expense after phase-out but before the taxable income limitation we discuss next.
Example 10-12
Answer: $857,160, computed as follows:
Description Amount Explanation
(1) Machinery $1,200,000 Exhibit 10-8
(2) §179 expense 800,000
(3) Remaining basis in machinery $ 400,000 (1) − (2)
(4) MACRS depreciation rate for 14.29% Rate from Table 1
7-year machinery
(5) MACRS depreciation expense $ 57,160 (3) × (4) on machinery
Total depreciation on machinery $ 857,160 (2) + (5) What if: Assume that Teton was eligible for and elected to claim the maximum amount of §179 expense. What would be its total current-year depreciation deduction, including MACRS depreciation and §179 expense (assuming the half-year convention applies)?
Answer: $1,028,580, computed as follows:
Description Amount Explanation
(1) Machinery $ 1,200,000 Exhibit 10-8
(2) §179 expense 1,000,000 Maximum expense in 2018
(3) Remaining basis in machinery $ 200,000 (1) − (2)
(4) MACRS depreciation rate for 14.29% Rate from Table 1 7-year machinery
(5) MACRS depreciation expense $ 28,580 (3) × (4) on machinery
Total depreciation on machinery $1,028,580 (2) + (5)
33Businesses typically elect only to expense the currently deductible amount since the taxable income limita- tion may also limit their §179 expense in future years just as it does for the current year. Electing the amount deductible after the taxable income limitation also maximizes the current year depreciation deduction.
What if: Assume further that on November 13, Teton acquired and placed in service a storage building costing $400,000. Taking the building into account, what is Teton’s maximum §179 amount after the phase-out?
Answer: $100,000, the same answer as above. The phase-out is based on the amount of tangible personal property placed in service during the year. Because the warehouse is real property (not qualified), its acquisition has no effect on Teton’s maximum §179 expense.
Businesses may elect to claim the §179 expense for the year up to the maximum amount available (after computing the phase-out—see the previous example). When a business elects to claim a certain amount of §179 expense, it must reduce the basis of the asset(s) to which the expense is applied. It then computes regular depreciation on the re- maining basis after reducing the basis of the asset(s) for the §179 expense.
A business’s deductible §179 expense is limited to the taxpayer’s business income after deducting all expenses (including regular and bonus depreciation) except the
§179 expense. Consequently, the §179 expense cannot create or extend a business’s net operating loss. Taxpayers’ business income includes income from all businesses.
For example, a sole-proprietor’s business income for purposes of §179 would include the income not only from all Schedules C but also from regular wages. If a business claims more §179 expense than it is allowed to deduct due to the taxable income limi- tation, it carries the excess forward (indefinitely) and deducts it in a subsequent year, subject to the taxable income limitation (but not the phase-out limitation) in the subsequent year.33
THE KEY FACTS
§179 Expenses
• $1,000,000 of tangible personal property can be immediately expensed in 2018.
• Businesses are eligible for the full amount of this expense when tangible personal property placed in service is less than
$2,500,000. Beginning at $2,500,000, the §179 expense is phased out, dollar-for-dollar. When assets placed in service reach $3,500,000, no §179 expense can be taken.
• §179 expenses are also limited to a business’s taxable income before the §179 expense. §179 expenses cannot create losses.
Example 10-13
What if: Let’s assume the facts of the previous example, where Teton’s maximum §179 expense after applying the phase-out limitation is $100,000. Also assume that Teton elects to claim the entire $100,000 expense and it chooses to apply it against the machinery. Further assume that Teton reports $400,000 of taxable income before deducting any §179 expense and depreciation.
What amount of total depreciation (including §179 expense) is Teton able to deduct on the machinery for the year?
Answer: $400,000, computed as follows:
Description Amount Explanation
(1) Machinery $2,400,000 Example 10-11
(2) Elected §179 expense 100,000
(3) Remaining basis $2,300,000 (1) − (2)
(4) MACRS depreciation rate for 14.29% See Table 1
7-year machinery, year 1
(5) MACRS depreciation expense $ 328,670 (3) × (4) on machinery
(6) Deductible §179 expense 71,330 Taxable income limitation ($400,000 − $328,670) (7) Total depreciation expense on $ 400,000 (5) + (6) machinery for the year
(8) Excess §179 expense $ 28,670 (2) − (6)
Choosing the assets to immediately expense. Businesses qualifying for immediate ex- pensing are allowed to choose the asset or assets (from tangible personal property placed in service during the year) they immediately expense under §179. If a business’s objective is to maximize its current depreciation deduction, it should immediately expense the asset
What if: Let’s assume that on June 1, Teton placed into service five-year property costing $1,400,000 and seven-year property costing $1,400,000 and had no other fixed asset additions during the year.
Further assume that Teton is not subject to the taxable income limitation for the §179 expense. What is Teton’s depreciation deduction (including §179 expense) if it elects to apply the full §179 expense against the five-year property (Scenario A)? What is its depreciation deduction if it applies the full §179 expense against its seven-year property (Scenario B)?
Answer: $1,280,060 if it applies the full §179 expense to the five-year property (Scenario A) and
$1,337,160 if it applies it to the seven-year property (Scenario B). See the computations below:
(Scenario A) (Scenario B)
§179 Expense §179 Expense on 5-Year on 7-Year
Description Property Property Explanation (1) Original basis $1,400,000 $1,400,000
(2) Elected §179 expense 1,000,000 1,000,000 Maximum expense
(3) Remaining basis 400,000 400,000 (1) − (2)
(4) MACRS depreciation rate 20% 14.29% See Table 1
(5) MACRS depreciation expense $ 80,000 $ 57,160 (3) × (4)
(6) Deductible §179 expense 1,000,000 1,000,000 Maximum §179 expense allowed this year.
(7) MACRS depreciation on 200,060 280,000 This is the depreciation
other property on the $1,400,000 7-year
property in the 5-year column ($1,400,000 × 14.29% = $200,060 and on the $1,400,000 5-year property in the 7-year column ($1,400,000 × 20% = $280,000).
Total depreciation expense $1,280,060 $1,337,160 (5) + (6) + (7)
Note that Teton deducts $57,100 more in depreciation expense if it applies the §179 expense to the seven-year property.
Example 10-14
What is the amount of Teton’s excess §179 expense (elected expense in excess of the deductible amount due to the taxable income limitation), and what does Teton do with it for tax purposes?
Answer: $28,670. See the above table for the computation (line 8). Teton carries this $28,670 excess
§179 expense forward to future years and may deduct it subject to the taxable income limitation. Note that the depreciable basis of the machinery remaining after the §179 expense is $2,300,000 because the depreciable basis is reduced by the full $100,000 of §179 expense elected even though the de- ductible §179 expense was limited to $71,330 in the current year.
Bonus Depreciation Since 2001, businesses have had the ability to immediately deduct a percentage of the acquisition cost of qualifying assets under rules known as bonus depreciation.36 The percentage allowable for each tax year during this period has changed many times ranging from 30 percent to 100 percent. Just prior to the TCJA, the bonus percentage was 50 percent. However, the TCJA increased the percentage to 100 percent for qualified property acquired after September 27, 2017. This provision (and the enhancement of §179) simplifies the depreciation calculation for many busi- nesses because they can deduct the full amount of certain assets placed in service dur- ing the year.37 There are several nuances of this provision that businesses need to consider. We discuss them in this section.
Bonus depreciation is mandatory for all taxpayers that qualify. However, taxpayers may elect out of bonus depreciation (on a property class basis) by attaching a statement to their tax return indicating they are electing not to claim bonus depreciation.38 That is, taxpayers can elect out of bonus depreciation for all of their 5-year class property but still claim bonus for all of their 7-year property acquisitions. The election to opt out of bonus depreciation is made annually. Businesses in a loss position may want to elect out of bo- nus depreciation to reduce these losses, which may be limited under the NOL rules. In addition, businesses may want to elect out of bonus and use §179 instead because §179 allows taxpayers to pick and choose carefully which assets to expense whereas bonus is all-or-nothing based on property class. For taxpayers claiming the deduction, bonus de- preciation is calculated after the §179 expense but before regular MACRS depreciation.39 Bonus depreciation is a temporary provision and the percentage phases down after five years.40 The bonus depreciation percentages by year are provided in Exhibit 10-9.
EXHIBIT 10-9 Bonus Depreciation Percentages41
Placed in Service Bonus Depreciation Percentage
September 28, 2017 – December 31, 2022 100 percent
2023 80 percent
2024 60 percent
2025 40 percent
2026 20 percent
2027 and after None
34Treasury Regulation §1.168(d)-1(b)(4)(i).
35Looking at Tables 2a and 2c in Appendix A, if a business has to choose between immediately expensing seven-year property placed in service in the first quarter or five-year property placed in service in the third quarter, which asset should it elect to expense under §179 if it wants to maximize its current-year deprecia- tion expense? The answer is the five-year asset because its first-year depreciation percentage is 15 percent, while the seven-year asset’s first-year depreciation percentage is 25 percent. Finally, note that businesses reduce the basis of the assets for the §179 expense before computing whether the mid-quarter convention applies.
36§168(k)(1).
37Many states do not allow bonus depreciation, so businesses will be required to calculate their depreciation using basic MACRS for those state tax returns.
38§168(k)(7). Property classes are broader categories of the asset classes discussed in Rev. Proc. 87-56. There are nine property classes of assets: 3-year, 5-year, 7-year, 10-year, 15-year, 20-year, 25-year, residential rental property, and nonresidential real property.
39Reg. §1.168(k)-1(a)(2)(iii) and Reg. §1.168(k)-1(d)(3) Example (2).
40§168(k)(6).
41A transition rule allows taxpayers to use a 50 percent bonus percentage for their first taxable year ending after September 27, 2017 [§168(k)(10)(A)].
with the lowest first-year cost recovery percentage including bonus depreciation (dis- cussed in the next section).34, 35
Qualified property. Taxpayers must first determine whether the assets acquired during the year are eligible for bonus depreciation. To qualify, property must meet the following requirements:42
(1) New or used property (as long as the property had not previously been used by the taxpayer),43
(2) Have a regular depreciation life of 20 years or less, (3) Computer software,44
(4) Water utility property, or
(5) Qualified film, television, and live theatrical productions.45
What if: Assume that Teton claims bonus depreciation for the eligible personal property acquired in Exhibit 10-8.
Asset Date acquired Cost Basis Recovery Period
Computers & 3/3/2018 $ 920,000 5
information systems
Delivery truck* 5/26/2018 80,000 5
Machinery 8/15/2018 1,200,000 7
Total $2,200,000
*Steve had used this truck personally and converted it to business use in May.
Assuming Teton elects no §179 expense, what is Teton’s bonus depreciation?
Answer: $2,120,000, computed as follows:
Description Amount Explanation
(1) Qualified property $ 2,120,000 All but the delivery truck (2) Bonus depreciation rate 100% §168(k)(1)(A) and §168(k)(6)(i)
Bonus depreciation $2,120,000 (1) × (2)
Note that the delivery truck is not eligible for bonus depreciation. Although used property usually qualifies, the truck is ineligible because Steve used the truck before converting it to business property.
The delivery truck’s cost will be recovered using basic MACRS rules.
Example 10-15
42Under prior law, qualified improvements were considered eligible for bonus depreciation, and Congress likely intended for this property to be eligible. However, due to a technical error in the TCJA, qualified improvement property is currently considered 39-year property and is not eligible for bonus depreciation (although it is eligible for §179).
43§168(k)(2)((E)(ii). Taxpayers may not use bonus depreciation for assets received as a gift or inheritance, for like-kind property (unless the taxpayer pays money in addition to the exchanged property), for property received in nontaxable exchanges (reorganizations), or for property acquired from a related entity.
44For this purpose, computer software means any program designed to cause a computer to perform a desired function. This software has a basic MACRS cost recovery period of five years.
45Qualified film, television, and live theatrical productions are defined in §181.
What if: Assuming Teton elects the maximum §179 expense, what is Teton’s bonus depreciation?
Answer: $1,200,000, computed as follows:
Description Amount Explanation
(1) §179 qualified property $ 2,200,000
(2) §179 expense 1,000,000 Maximum expense
(3) Remaining basis $ 1,200,000 (1) − (2)
(4) Remaining amount eligible 1,200,000 Remaining amount relates to the for bonus depreciation computers and the machinery. Because
the truck is not eligible for bonus depreciation, we apply the §179 expense first to the truck to maximize the current-year depreciation deduction.
We next apply the §179 expense to the machinery (7-year), which reduces its basis to $280,000.
(5) Bonus depreciation rate 100% §168(k)(1)(A) and §168(k)(6)(A)(i) (6) Bonus depreciation $1,200,000 (4) × (5)
What if: Assuming Teton elects the maximum §179 and bonus depreciation, what is Teton’s total de- preciation on its personal property?
Answer: $2,200,000. Teton is able to fully depreciate its tangible personal property placed in service in 2018 due to a combination of §179 ($1,000,000) and bonus depreciation ($1,200,000). Teton does not need to calculate regular MACRS depreciation on any of its tangible personal property. Alterna- tively, Teton could elect to take §179 on the delivery truck only and use bonus depreciation on the remaining assets. This option would produce $80,000 of §179 expense and $2,120,000 of bonus depreciation, for a total of $2,200,000.
THE KEY FACTS Listed Property
• When an asset is used for both personal and business use, calculate the business- use percentage.
• If the business-use percent- age is above 50 percent, the allowable depreciation is limited to the business- use percentage.
• If a listed property’s business-use percentage ever falls to or below 50 percent, depreciation for all previous years is retroactively restated using MACRS straight-line method.
Listed Property Most business-owned assets are used for business rather than personal purposes. For example, Weyerhaeuser employees probably have little or no personal interest in using Weyerhaeuser’s timber-harvesting equipment during their free time. In contrast, business owners and employees may find some business assets, such as company automobiles or laptop computers, conducive to personal use.
Business assets that tend to be used for both business and personal purposes are re- ferred to as listed property. For example, automobiles, other means of transportation (planes, boats, and recreation vehicles), and even digital cameras are considered to be listed property. The tax law limits the allowable depreciation on listed property to the por- tion of the asset used for business purposes.
How do taxpayers compute depreciation for listed property? First, they must determine the percentage of business versus personal use of the asset for the year. If the business-use percentage for the year exceeds 50 percent, the deductible depreciation is limited to the full annual depreciation multiplied by the business-use percentage for the year. Listed property used in trade or business more than 50 percent of the time is eligible for the §179 expensing election and bonus depreciation (limited to the business-use percentage).
46This is the alternative recovery period listed in Rev. Proc. 87-56. See §168(g)(3)(C) and Reg. §1.280F-3T(d)(1).
47However, there are exceptions to this general rule. For example, the ADS recovery period for certain machin- ery for food and beverages is 12 years and the ADS recovery period for machinery for tobacco products is 15 years. Thus, it is important to check Rev. Proc. 87-56 to verify the ADS recovery period in these situations.
What if: Assume that, in addition to the assets Teton purchased in 2018 presented in Exhibit 10-8, it also purchased a new digital camera for $2,000 that its employees use for business on weekdays. On weekends, Steve uses the camera for his photography hobby. Since the camera is listed property, Teton must assess the business-use percentage to properly calculate its deductible depreciation for the cam- era. Assuming that Teton determines the business-use percentage to be 75 percent, what is Teton’s depreciation deduction on the camera for the year (ignoring bonus depreciation and §179 expensing)?
Answer: $300, computed as follows:
Description Amount Explanation
(1) Original basis of camera $2,000
(2) MACRS depreciation rate 20% 5-year property, year 1, half-year convention (3) Full MACRS depreciation expense $ 400 (1) × (2)
(4) Business-use percentage 75%
Depreciation deduction for year $ 300 (3) × (4)
Example 10-16
When the business-use percentage of an asset is 50 percent or less, the business must compute depreciation for the asset using the MACRS straight-line method over the MACRS ADS (alternative depreciation system) recovery period.46 For five-year assets such as automobiles, the assets on which the personal-use limitation is most common, the MACRS ADS recovery period is also five years. However, for seven-year assets, the ADS recovery period is generally 10 years.47
If a business initially uses an asset more than 50 percent of the time for business (and appropriately adopts the 200 percent declining balance method, §179, or bonus depreciation) but subsequently its business use drops to 50 percent or below, the depre- ciation expense for all prior years must be recomputed as if the business had been using the straight-line depreciation over the ADS recovery period the entire time. The firm must then recapture any excess accelerated depreciation (including §179 and bonus depreciation) it deducted over the straight-line depreciation that it should have deducted by adjusting the current-year depreciation. In practical terms, the business can use the following five steps to determine its current depreciation expense for the asset:
Step 1: Compute depreciation for the year it drops to 50 percent or below using the straight-line method (this method also applies to all subsequent years).
Step 2: Compute the amount of depreciation the taxpayer would have deducted if the taxpayer had used the straight-line method over the ADS recovery period for all prior years (recall that depreciation is limited to the business-use percent- age in those years).
Step 3: Compute the amount of depreciation (including §179 and bonus deprecia- tion) the taxpayer actually deducted on the asset for all prior years.
Step 4: Subtract the amount from Step 2 from the amount in Step 3. The difference is the prior-year accelerated depreciation in excess of straight-line depreciation.
Step 5: Subtract the excess accelerated depreciation determined in Step 4 from the current-year straight-line depreciation in Step 1. This is the business’s allowable depreciation expense on the asset for the year. If the prior-year excess deprecia- tion from Step 4 exceeds the current-year straight-line depreciation in Step 1, the business is not allowed to deduct any depreciation on the asset for the year and must recognize additional ordinary income for the amount of the excess.
This five-step process is designed to place the business in the same position it would have been in if it had used straight-line depreciation during all years of the asset’s life.