We are approaching the halfway mark of 2022, the final year of 100% Bonus Depreciation. There really isn’t anything much more generous in the tax code than spending millions of dollars on an asset and deducting the entire investment in the same year. The 2017 Tax Cuts and Jobs Act (“TCJA”) is the source of the enhanced bonus depreciation rates and the addition of new types of eligible property.
What is bonus depreciation?
The Internal Revenue Code (“IRC”) defines bonus depreciation as an additional first-year deduction for certain qualifying business property purchased and placed in service during the tax year. Generally speaking, qualifying property is any property that has a recovery period under the Modified Accelerated Cost Recovery Systems (“MACRS”) of 20 years or less. Prior to the TCJA, bonus depreciation was limited to 50% of the cost of qualifying property placed in service during the tax year. Under the TCJA, bonus depreciation allows for a 100% first year deduction for new and used qualified business property that is acquired and placed in service after September 27, 2017 and before January 1, 2023.
After December 31, 2022, the deduction for first-year bonus depreciation changes according to the following schedule:
- 80% for property placed in service between January 1, 2023 and December 31, 2023.
- 60% for property placed in service between January 1, 2024 and December 31, 2024.
- 40% for property placed in service between January 1, 2025 and December 31, 2025.
- 20% for property placed in service between January 1, 2026 and December 31, 2026.
The TCJA also expanded which property qualifies for bonus depreciation to include used property as well, as long as it is not purchased from a related party. This was a welcome change to the IRC as bonus depreciation was previously limited to new property only.
These rules are always subject to change when Congress needs additional revenue for other purposes.
Claiming bonus deprecation on lesser-known property
At first glance, a gas station may appear to be classified solely as non-residential real property, which is required to be depreciated under MACRS with a recovery period of 39 years and therefore not eligible for bonus depreciation. This is not the case if the gas station meets the definition of a “retail motor fuel outlet.” To qualify as such, the gas station must meet one of the following three tests:
- 50% or more of the gross revenues are derived from petroleum sales, or
- 50% or more of the total property floor space is devoted to petroleum marketing sales, or
- The convenience store building on the property is 1,400 square feet or less.
As long as at least one of the three tests above are met, the property will treated as Section 1250 property with a recovery period of 15 years, thus making it eligible for bonus depreciation. This can result in substantial first-year tax savings for investors looking to purchase or acquire a gas station.
Purchasing an aircraft can be quite expensive, thus it may come as a surprise that the IRC allows for a taxpayer to fully deduct the cost of the aircraft under the bonus depreciation rules. First and foremost, in order for an aircraft to be eligible the IRS states that it must meet the 50% qualified business use test. This simply means that the aircraft must be used for business purposes at least 50% of the time. A business purpose could include transportation of goods or even charter flights. If this test cannot be met, then the asset does not qualify for bonus depreciation. Instead the taxpayer will be required to use the straight-line depreciation method.
Boats have similar rules to aircraft when it comes to bonus depreciation. Again, the boat must meet the 50% qualified business use test. Generally, if a boat is purchased with the intention of using it in a charter business or commercial fishing, this would qualify the purchased boat to be eligible for bonus depreciation. The 100% bonus depreciation can trigger a fairly large deduction which can be utilized to offset the taxpayer’s other income if the taxpayer is both actively engaged in the trade or business and materially involved during the tax year in which the bonus depreciation is used.
Buyer beware! If the purchased aircraft or boat fails the 50% business use test in any year, the taxpayer is required to use the Alternative Depreciation System (“ADS”) for calculating depreciation in that year and all future years. The taxpayer must also recapture and include in their income any excess depreciation that was deducted in previous years over what should have been deducted using the ADS life and method.
One final important item to note is that any personal usage of depreciable property will reduce the depreciation deduction. Even though the 50% business use test may be met in the case of an aircraft or a boat, if the property is used 25% of the time personally, then the total bonus depreciation deduction will be reduced by 25%.
Count on Friedman
Whether you are looking to purchase property for your trade or business or invest in an existing business, your Friedman LLP advisor can help you navigate through the murky waters (or skies) of bonus deprecation.