There are many tax incentives that allow a business to immediately deduct a large percentage of the purchase price of eligible assets, such as machinery, rather than write them off over the “useful life” of that asset.
Bonus Depreciation
Bonus depreciation allows a taxpayer to deduct up to 100% of the cost of certain assets in the year of acquisition, rather than depreciating the assets over their useful life. Bonus depreciation can be applied to assets with a recovery period of 20 years or less. Eligible assets include qualified improvement property, land improvements, machinery & equipment, furniture & fixtures, and purchased software. Bonus depreciation must be taken in the year that the assets are placed in service and may be taken on new or used purchases. A taxpayer may elect out of bonus depreciation. This is an annual election, and the election must be attached to the timely filed tax return.
Prior to 2017, bonus depreciation was limited to 50% and was set to phase out. The Tax Cuts and Jobs Act of 2017 has extended and updated the rules for bonus depreciation. Assets placed in service between September 28, 2017, and December 31, 2022, are eligible for 100% bonus depreciation. Starting January 1, 2023, bonus depreciation will decrease to 80% and the rates will decline 20% each year until 2027, when it will cease to exist (unless further legislation comes into play).
Section 179 Deduction
The Section 179 deduction allows a taxpayer to deduct up to $1,050,000 of newly acquired assets per year, rather than capitalizing and depreciating them. This amount is for the 2021 tax year and is to be adjusted each year for inflation. Assets eligible for the Section 179 deduction include tangible personal property, such as machinery & equipment, furniture & fixtures, and purchased computer software. Certain improvements to nonresidential real property, such as roofing, HVAC, fire & alarm systems, and security systems, are also eligible for the Section 179 deduction. The section 179 deduction may be taken on new or used purchases and must be taken in the year of acquisition.
For 2021, the Section 179 deduction phases out dollar for dollar once new purchases exceed $2,620,000, and the deduction completely phases out once eligible purchases reach $3,670,000. These thresholds are adjusted annually for inflation.
Qualified Improvement Property
Qualified improvement property (QIP) is any improvement made by a taxpayer to the interior of a commercial building after the building was originally placed in service. The improvements must be made by the taxpayer; a taxpayer cannot purchase a building then assign costs made by the previous owner to QIP.
Certain improvements, such as enlargements to the building, elevators & escalators, and structural framework, do not qualify as QIP.
Qualified improvement property should be depreciated using the straight-line method over 15 years, and is is eligible for bonus depreciation, QIP is also eligible for the Section 179 deduction.
Section 179D Energy Efficient Commercial Building Deduction
The Section 179D deduction is a tax deduction available to building owners who install energy efficient building systems to their commercial buildings. These systems include the building envelope; interior lighting; heating, cooling, ventilation systems, & HVAC; and hot water systems. The systems must reduce the total annual energy and power costs of the building by at least 50% when compared to the minimum requirements of the American Society of Heating, Refrigeration, & Air-Conditioned Engineers reference building. The deduction is available for both new constructions and remodeled buildings.
The maximum deduction for any building in any tax year is $1.80 (to be adjusted each year for inflation) per square foot of the building. The deduction cannot exceed the cost of the qualifying systems. If a deduction is allowed, the basis of the building will be reduced by the amount of the allowable deduction. The taxpayer will also report the deduction as a separate line item under other expenses. For buildings that only partially qualify, deductions of up to $.60 per square foot are available.
To claim a deduction for Section 179D, a Section 179D study must be done by a qualified third party. The third party will conduct a site visit and verify that the property meets the energy efficiency requirements. The Section 179D deduction should be taken in the year the building systems are placed in service but can also be taken retroactively by filing an amended tax return, or filing Form 3115, Change in accounting method.
In 2020, as part of the Consolidated Appropriations Act of 2021, the Section 179D deduction was made a permanent part of the US Tax Code.
Section 45L Energy Efficient Home Credit
The Section 45L credit is available to owners of qualifying residential buildings. Like the 179D deduction discussed above, the residential dwelling units must contain energy efficient building systems, such as the building envelope and heating and cooling equipment. The dwelling unit must have an annual level of heating and cooling energy consumption which is at least 50% below the annual level of a comparable dwelling unit. The building envelope must account for 1/5 of the 50% reduction in energy consumption. The credit applies to single family homes, apartments (less than four stories high), townhouses, condominiums, student housing, affordable housing, and assisted living homes. The building must be located in the United States. New constructions and remodeled residential buildings are eligible for this credit.
The maximum credit is $2,000 for each qualifying dwelling unit. The basis of the building should be reduced by the amount of the 45L credit. The taxpayer must claim the credit by filing form 8908, Energy Efficient Home Credit. A credit of $1,000 is available for homes that meet fewer demanding standards.
To claim a credit for Section 45L, a qualified third party must conduct a site visit and verify that the property meets the energy efficiency requirements. The credit should be claimed in the year the residential dwelling units are placed in service. The credit can also be claimed retroactively.
Currently, the 45L credit is set to expire at the end of 2021.
These are federal tax regulations. Each state has their own set of regulations and may or may not follow federal laws.
