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How to Maximize Tax Deductions

The Tax Cuts and Jobs Act (TCJA) changed limitations for small business capital expenditures. It increased both section 179 limitations for expensing and bonus depreciation percentages. Allowing businesses to deduct the full purchase price of long term assets such as equipment, office furniture, cell phones, computers, and vehicles. Recently the CARES Act, passed in March 2020, made changes to legislation that extended the same tax benefit to qualified improvement property.

Bonus Depreciation

Depreciation allows the cost of the asset to be deducted over several years. Business owners may take an additional first-year deduction this is known as bonus depreciation. The TCJA increased the bonus percentages for a limited time. 

Businesses are allowed to immediately deduct 100 percent of the cost of eligible property placed in service after September 27, 2017, and before January 1, 2023, after which it will be phased downward over a four-year period: 80 percent in 2023, 60 percent in 2024, 40 percent in 2025, and 20 percent in 2026.

Section 179 Expensing

U.S. tax code section 179 is an election that allows business owners to expense the full purchase price of a long-term asset within a single tax year to offset the financial loss. Businesses should take advantage of Section 179 expensing this year whenever possible. In 2020, businesses can elect to expense (deduct immediately) the entire cost of most new equipment up to a maximum of $1.04 million of the first $2.59 million of property placed in service by December 31, 2020. Keep in mind that the Section 179 deduction cannot exceed net taxable business income. The deduction is phased out dollar for dollar on amounts exceeding the $2.59 million threshold and eliminated above amounts exceeding $3.63 million.

There are certain requirements for the business property to qualify for section 179. The property must be placed in service during the tax year that you claim the deduction. It must also be used more than 50 percent of the time in your trade or business. Property that is placed in service and then disposed of in that same tax year does not qualify, nor does property converted to personal use in the same tax year it is acquired.

For property placed in service in taxable years beginning after December 31, 2017, taxpayers can elect to include certain improvements made to nonresidential real property after the date when the property was first placed in service.

  1. Roofs, HVAC, fire protection systems, alarm systems, and security systems.
  2. Qualified Improvement Property (defined below)

CARES Act and Qualified Improvement Property

A Qualified Improvement Property (QIP) is any improvement to an interior portion of a building that is a nonresidential real property if the improvement is made after the date the building was first placed in service. Qualified improvements to a property can include installation or replacement of drywall, ceilings, interior doors, fire protection, mechanical, engineering, and plumbing. However, improvements do not qualify if they are attributable to the enlargement of the building, any elevator or escalator or the internal structural framework of the building.

QIPs were generally depreciated over a period of 39 years. The TCJA intended to assign a 15-year recovery period to a QIP and make it eligible for 100 percent bonus depreciation. However, an error in drafting the legislation language blocked this change.

  • The CARES Act makes technical amendments that give qualified improvement property (QIP) a 15-year depreciation period and makes them eligible for 100% bonus depreciation. Businesses can immediately deduct 100% of the cost of improving facilities, rather than having to depreciate improvements over 39 years.

This provision is effective for property placed in service after December 31, 2017. Since the change to qualified improvement property is retroactive to January 1, 2018, taxpayers may have an opportunity to amend their 2018 and 2019 returns to claim bonus depreciation.

Timing for purchase of business equipment.

The tax rules for depreciation include “conventions” or rules for figuring out how many months of depreciation you can claim. You might be able to increase your tax benefit if you buy equipment at the right time. There are three depreciation conventions (1) the half-year convention, (2) the mid-year convention, and (3) the mid-month convention. To select the correct convention, you must know the type of property and when you placed the property in service.

  1. Most property uses the half-year convention: the property that you begin using during the year is treated as “placed in service” (or “disposed of”) in the middle of the year. If the half-year convention applies, you get one-half year of depreciation on that machine.
  2. Late purchases can trigger the mid-quarter convention: Use the mid-quarter convention if the cost of equipment placed in service during the last three months of the tax year is more than 40 percent of the total cost of all property placed in service for the entire year. If the mid-quarter convention applies, the half-year rule does not apply, and you treat all equipment placed in service during the year as if it were placed in service at the midpoint of the quarter in which you began using it.
  3. Mid-month convention: This convention applies only to residential rental property and nonresidential real property. It treats all property placed in service (or disposed of) during any month as placed in service (or disposed of) at the midpoint of that month.

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