Mastering the Maze of Bonus Depreciation and Deductions

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Yeah , it's nice , I have to mow my lawn more often now .

So first of all , we probably should just talk about what is depreciation and when do we use it .

So , for example , you go out and you buy copier paper and copier toner that's going to get used up within the year . You write that off in the year you buy it . But let's say you go and you buy yourself a brand new copier and you spend , you know , $10,000 on this piece of equipment that's going to last for seven years .

Well , the IRS doesn't want you to just write off $10,000 in the year that you purchased it , because this is something that has a lifespan of more than one year . They want you to stretch it out . So in this case , you would depreciate this over the recovery period , which , in the case of a copier , would be seven years .

And you know , different assets have different recovery periods . Some can be short , as you know , three years . Some can be as long as 15 or 20 or , if it's real estate , it could be even , you know , 39 years . But that's the big difference between , like , a normal expense and a capital asset that has to be depreciated .

So you can't depreciate something that you don't actually own . So if you're renting a car , that's different than if you own a car . If you're renting a copier , lease payments would be immediately expensed , whereas purchasing a copier they would be depreciated . The second question is is the property being used in a business to produce income ?

So only business property gets depreciated . Your personal property , your personal vehicle or jet ski or camper , those do not get depreciated unless you're using that to generate income in a in an actual business . If you're using it for hobby income , then there's no , there's no deduction . The third question is does the property have a determinable useful life ?

Most things that you buy are going to have a determinable useful life . We can kind of put a number on how long a copier lasts or how long a tool is going to last . Things that are kind of like intangible things , like patents , non-compete agreements , those those are handled with amateurization and are kind of outside the scope of what we're talking about .

And then is that useful life more than one year ? If it's more than one year , it gets depreciated . If it's going to be used up and consumed within one year , we just write it off as an expense in that year .

And just kind of a little side note on that you know , we can probably imagine some situations where we have very inexpensive assets that are going to last more than one year . You know , maybe we buy a $400 laptop or , you know , a thousand dollar cell phone seems like kind of a nuisance to a screwdriver .

Yes , yes , although , although if you use a screwdriver like I do , you might not get a full year out of it . You're probably better with your tools than I am , yeah , but yeah , right , you don't want to have to depreciate a screwdriver , so the IRS does have a safe harbor . It's $2,500 .

If you purchase something $2,500 or less and you want to write that off fully in the year you buy it , you go ahead and do that , even if it does have , you know , more than than one year's worth of life .

What we'll talk about and then the other assets that you might have in your painting business would be vehicles . Obviously , there's an asset that lasts several years , so that might be another type of asset that you have . Or maybe a generator , so those kind of larger big tools or equipment .

And then , and vehicles I think would apply to a lot of painting business owners out there those are the kinds of things that would have a depreciation applied to them .

There's always the exception to the rule .

We have things that can accelerate depreciation , namely section 179 of the tax code and more recently , we have what's called bonus depreciation , and these are provisions that allow us to either fully expense these capital assets in the year that they're purchased or expense a portion of the more that we normally would be able to .

So section 179 has been around for quite a while , but bonus depreciation is new since 2018 . Bonus depreciation kind of expands on what section 179 does and does it a little bit better , but it's also a temporary provision . So from 2018 to 2022 , being last year bonus depreciation was available for 100% .

You buy a $10,000 paint sprayer , you write off the full $10,000 . Now that we're in 2023 , we're starting to see bonus depreciation phase down . 2023 , we're down to 80% . So now with that paint sprayer , we're only writing off $8,000 . Next year it will be 60% 2025 , 40% 2026 , 20% and then it's designed to phase out completely in 2027 . Will that actually happen ?

We're gonna have to wait to see what Congress decides . There's a lot of provisions in the Tax Cuts and Jobs Act that we don't know what it's gonna be around in the next few years . So if you're listening to this , five years from now there may be some changes , but as of now , those are the phase outs .

Now , bonus depreciation is kind of interesting because , whereas with section 179 , you opt in , in other words , you say I choose to take this piece of equipment and accelerate depreciation , bonus depreciation you opt out of . Bonus depreciation is the default mode .

So the IRS is assuming that you're going to use this on all of your assets unless you tell them you don't want to . The other thing is that it has to . Whatever you do for one asset in a recovery period , you have to do for all those assets .

No , what I mean by that is let's say , you have five pieces of equipment that is a seven year recovery equipment . If you , by default , all five pieces are going to be bonus depreciated . If you opt out , then none of them will be bonus depreciated , but what you can't do is pick one or two and not the others .

If you want to do that , it is available through section 179 , but that is a big difference between bonus and section 179 .

A lot of times that makes sense because keeping our money , we can put that money to work for us , we can do good things with it . But there may be some situations where you don't want to use up your tax deduction all in the first year . So , for example , let's say you have not a great year and you don't have a lot of income .

Well , lower income means lower tax bracket . If I use up all my tax deduction now , what happens in the future when I have more income and am in a higher tax bracket ?

If I have $10,000 of deductions available to me , I would rather use that when my tax bracket is 35% than use it when my tax bracket is 12% , and so it might make sense to stretch that out so that you are saving deductions for future years if they're gonna be more valuable to you in future years .

Another thing we wanna think about that this gets overlooked a lot , so I really wanna draw attention to this is that when we sell the asset , a lot of times we don't use things up completely . Let's say we buy a pickup truck .

If we drive the wheels off of it and it goes to the junkyard , then we don't have anything to worry about because we fully depreciated it . It has no residual value . But what happens if we drive it for a few years and then we sell it and say we get $20,000 for our truck ?

If we've already depreciated it , then we have to pay back that tax break when we go to sell it . So if it's fully depreciated and we sell it for $20,000 , now we're paying taxes on $20,000 and we might be in that higher tax bracket when we do it . This also applies if we trade that truck in .

Now , I didn't always this is a recent change but if you trade your vehicle in to get a new one , whatever the dealer gives you for that vehicle would be the sale price of that vehicle , and so we gotta take that into consideration . If we fully depreciated it and the dealer gives us $20,000 for it , we're gonna be on the hook for some extra taxes .

Yeah , this came up in the last year .

But then it was like a year or two later he was trying to trade that same vehicle in for a new , to upgrade , get a new vehicle for the newest model . And we're like hey , you took the section 179 a couple of years ago on this , so now you're going to have to pay that depreciation , accelerated depreciation you took back to the IRA .

So you can't take section 179 one year and then two years later trade it in and do it in section 179 again . You can't keep just taking section 179 . A lot of folks don't realize that . They go oh , I can just fully expense it as long as it meets the section 179 requirements .

Then I can just keep doing that and just trading my vehicles and getting a big deduction .

So we can't take the pickup truck that we were using for work and then give it to ourselves a few years later and not expect to recapture that depreciation . So definitely a conversation to have with your tax preparer and try to understand , like the long term effects .

It may very well be in your interest to get your tax break upfront , especially if you're going to completely use up that vehicle . But if you intend to trade it in right away or you intend to maybe convert that to personal use within a year or two , be aware of the consequences of accelerating depreciation .

But looking at their situation it didn't really make sense based off of the cost of their vehicle and the amount of mileage they're putting it on , putting on their vehicle .

Could you talk like a little bit about when would be a time where you might not want to do the bonus depreciation or section 179 on a vehicle that has high mileage and maybe isn't that expensive ? Sure ?

But if you are able to use the standard mileage deduction so the IRS is if you don't want to figure out actual expenses so actual depreciation , actual fuel , actual maintenance you can use a sense per mile formula to figure out what your deduction should be . That formula is adjusted each year .

This year it is 65 and a half cents per mile , so you would log your mileage and I cannot emphasize the importance of keeping an accurate mileage log for deductions . Log your mileage , multiply that by 65 and a half cents . That's your deduction . In some cases , if you have a

inexpensive vehicle or a very fuel efficient vehicle or a vehicle that is does not cost you a lot to operate , you may find yourself much better off taking 65 and a half cents per mile versus using actual expenses and depreciation .

Conversely , let's say you're a doctor who likes to drive a $150,000 Porsche and you only drive it to the clinic that's a few miles away once a week . You're not going to have a lot of mileage there and you're going to have a lot of depreciation . In that extreme situation , actual expenses are going to be a lot more advantageous to this doctor .

But most of us are not in that situation . So again , talk to your tax professional . Does it make more sense to take actual expenses or do I have a very efficient , low operating cost vehicle and it might be more beneficial to do this cents per mile ?

Just make sure you're tracking that . There are some apps out there that can help you track it a little bit easier . Mylot IQ is one where it remembers , like if you're going .

It kind of remembers your routes and classifies it as business or personal based off of your driving habits and stuff , and then it will give you a compliant mileage log at the end of the year that you can have for your records . So it makes it a little bit easier .

Obviously , you can also just have a book on your dash and then just write your mileage and track business and personal , which is kind of a little arduous , but that will definitely meet the requirement . But MyLot IQ , I think , is pretty relatively cheap .

And then I don't think it needs to be contemporaneous , so it needs to be filled out when the driving happens . If we wait to the end of the year and we try and reconstruct it from memory , those logs usually get disallowed under examination .

So this is kind of a cover your butt type thing and I know it's a pain in the neck and we don't really want to have to add more paperwork to our day . But because the mileage deduction or vehicle deductions in general are so valuable , it is worth doing the extra record keeping .

Residential is 27 and a half years , commercial is 39 . But we might be able to use bonus depreciation on the things inside the building , things that are not components of the building Furniture , fixtures , things like that . I heard a tax professional . She gave a neat illustration .

She said that when she was a young girl she had one of those Barbie dream homes with the plastic satin , with all the little things inside . She said if I took the roof off my Barbie dream home , I turned it upside down and I shook it . Whatever falls out I can probably bonus depreciate . Whatever stays in is going to be a component of the real estate .

Take that the greatest salt . But I thought that was pretty smart . If you're buying real estate and you want to try to increase some of your expenses , look for things that would fall out under a shake test . Generally speaking , some other aspects of bonus depreciation Section 179 required that the asset be brand new .

Bonus depreciation just requires that the asset be new to you . If you purchase a used vehicle or used equipment , bonus depreciation can apply , but it does have to be acquired by purchase . It can't be gifted to you . You can't inherit it from Uncle Fred . It does need to be something that you pay for with money . You can combine bonus and Section 179 .

Section 179 is limited to about $1.2 million per taxpayer per year . Bonus does not have a limit . These tax strategies can certainly be valuable if used properly . Jumping back to vehicles , I did want to mention that there is a limit on how much you can depreciate certain vehicles in the first year .

If you have a vehicle that can be used for both personal and business use , like a sedan or a typical car , and that vehicle is less than 6,000 pounds , you are limited to $20,200 maximum depreciation in the first year . That's bonus and Section 179 , that's the max . However , if you have an SUV that weighs more than 6,000 pounds , then there is no limit .

Tesla was using this as a selling point for their Model X . Because the Model X was technically over 6,000 pounds , people were buying these , putting them into their businesses and being able to fully depreciate them in the first year .

If you have a vehicle that is not practical for passenger use so let's say a work van that only has the two seats up front and the rest is built out for cargo Even if that's under 6,000 pounds , you can go ahead and fully depreciate that , because that is business only . There is no practical personal use there .

A lot of different rules , a lot of different nuance . We're not going to cover everything today .

I'm also going to recommend that you have this conversation well before the end of the year , because you may choose to make some purchases before December 31st , based on income tax liability , the fact that bonus depreciation is getting reduced by 20% each year .

So there's a lot of tax planning opportunities here , but we need to be proactive and we need to have intentional planning to make sure that we're getting the most out of them .

We'd love to hear from you .

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