Making the Most of Tax Deductions with Declining Bonus Depreciation

At a glance

• The main takeaway: The Senate rejected the Tax Relief for American Families and Workers Act of 2024, which was intended to expand the child tax credit and restore tax breaks under the Tax Cuts and Jobs Act (TCJA) for certain businesses.
• The impact on your business: Since the bill’s rejection, many companies will face ongoing tax challenges moving forward, such as diminished bonus depreciation.
• Next steps: Schedule a consultation with Aprio’s Cost Segregation team to learn more about how changes in this legislation may impact you.

The Full Story

On January 31, 2024, the House of Representatives passed its version of the Tax Relief for American Families and Workers Act of 2024, which would have temporarily reinstated several tax benefits, including the continuation of 100% bonus depreciation. However, the bill was rejected on August 1^st in the Senate. As a result, many businesses could experience negative impacts.

Bonus Depreciation

For companies with capital expenditures, the phase-out of bonus depreciation is an especially hard-hitting impact of the rejected bill. Bonus depreciation is a unique tax rule that allows business taxpayers to write off a large percentage of an eligible asset’s cost in the first year it is purchased, contrary to normal depreciation rules in which businesses may be required to spread out the cost of capital purchases over many years.

Under the TCJA, taxpayers could deduct 100% bonus depreciation for qualified property from September 2017 through the end of 2022. This was a considerable improvement compared to the previous rules for bonus depreciation, which only enabled taxpayers to deduct 50% in most years.

As written in the TCJA regulations, the phaseout of bonus depreciation began in 2023 with a 20% reduction. The bonus percentage will continue to decrease by an additional 20% each year for property placed in service until January 1, 2027, as exhibited in the table below:

TAX YEAR	BONUS DEPRECIATION PERCENTAGE
2022	100%
2023	80%
2024	60%
2025	40%
2026	20%
2027	0%

In light of this, taxpayers should look to other means in the tax code for maximizing deductions with rules that have been in place prior to the TCJA.  

Considerations for Capital Expenditures: Depreciate or Expense?

A business must review the facts and circumstances of its capital expenditures to determine the proper treatment of an asset. The rules can be complex and cumbersome and may fall under different rules passed at different times in multiple IRC sections. Some questions a taxpayer should consider are:

• Is this real or personal property (i.e., what is my unit of property)? 
• Is this property replacing other property?
• Is this a repair to existing property?
• Is there a rule, safe harbor, or some other provision that let my organization expense this purchase? 
• Should whole or partial dispositions be reviewed?

To understand the implications of these questions, taxpayers should assess the following:

1. What is Unit of Property (UoP) in review? The UoP is the reference point upon which capitalization standards are applied. For instance, according to IRS Code §1.263(a)-3(e)(2) , a building is considered a UoP. However, a single building will contain different systems, and capitalization standards are applied at the system rather than at the building level.

For non-building UoP’s, the property may be considered a single UoP or part of a larger UoP. Expenditures such as these should be reviewed on a case-by-case basis under the guidance of a tax advisor.

2. Is the expenditure replacing existing property? Businesses should consider whether the expenditure is replacing existing property to determine if it may qualify as an expense under the Tangible Property Regulations. Does this expenditure keep the UoP in normal operating condition, or is it extending the life of the property? Is the expenditure a replacement of similar property or an improvement? Depending on these and other factors, these costs may qualify as a repair and maintenance expense, in which the entire amount or a portion of the amount may be in the year the expenditure took place.

3. Does the expenditure meet the requirements of Qualified Real Property (QRP)? QRP is eligible for expensing under §179 and can include roofs, HVAC, ventilation, air conditioning, fire protection, alarm systems, and security systems expenditures to existing commercial properties. QRP also includes Qualified Improvement Property (QIP), which encompasses non-structural interior improvements to a commercial building that has already been placed in service but does not include building expansions. Notably, not all taxpayers qualify for §179 expensing, and there are limits on how much may be deducted.

4. Are safe harbors applicable? Depending on the size of the business, the value of the purchase, and type of expenditure, businesses may elect to use a safe harbor to expense, rather than capitalize, certain assets. For example, one or more of the following examples might apply to a given business:

• Routine Maintenance Safe Harbor: allows businesses to immediately deduct the costs of regular, expected maintenance activities on their property.
• De Minimis Safe Harbor: allows businesses to immediately deduct the cost of small, low-value purchases of tangible property, up to $2,500 per item or invoice (or $5,000 with an applicable financial statement).
• Safe Harbor for Small Taxpayers: allows small businesses with average gross receipts of $10 million or less and properties valued at $1 million or less to immediately deduct certain repair, maintenance, and improvement costs.

To take advantage of these safe harbors, there are statements that must be included with the tax return or accounting methods at the time of filing. Consult with your tax advisor to determine whether you can benefit from these tax advantages.

If a taxpayer assesses all the considerations described above and determines the expenditure must be capitalized, the property replaced may be disposed of as a full or a partial disposition. Dispositions of full assets are generally not elective and should be disposed of in the year the property is replaced, while partial dispositions are elective. If electing partial building dispositions; if a proper cost segregation study has been performed, the information should be available in the study to value the disposed property. If a study was not completed, the IRS does not specify a particular method for identifying and valuing the disposition. However, the IRS does recommend the use of the PPI Index as one way to establish these values. Your tax advisor can help navigate the disposition rules.           

The Bottom Line

Since the Senate did not pass the Tax Relief bill, increasing first-year deductions under bonus depreciation will continue to decrease in future years unless new legislation is approved by collaborative efforts across the aisle. Tax legislation is typically also closely linked to the political landscape, so Congress is not expected to take any further action on the matters included in the failed Tax Relief bill until after the 2024 presidential election.

While taxpayers are forced to operate under the current legislation, it is beneficial for businesses to decide on the best tax treatment of their capital expenditures. Taxpayers have the right to explore alternative strategies to maximize tax deductions and increase savings. Given the IRC code sections, rules, and regulations that guide these determinations can be highly complex, Aprio strongly recommends discussing your options with a trusted tax professional.

If you’re uncertain how the results of the rejected legislation may impact your tax obligations, consult with our team of advisors to learn more.