Section 168 deduction
Individuals and businesses are often on the lookout for tax incentives that aid in reducing their tax liabilities. One such provision is made by the Section 168 deduction, this is a section of the U.S Internal Revenue Code that provides rules for the depreciation of property used in a trade or business. It allows taxpayers to recover the cost of qualifying property through depreciation deductions over the property’s useful life. Section 168 provides for several different methods of depreciation, including the Modified Accelerated Cost Recovery System (MACRS), which is the primary method of depreciation for most types of property.
Here, we shall discuss the Section 168 deduction, its yearly phase-out percentages, and some differences between the Section 168 deduction and Section 179.
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What is the Section 168 deduction?
The Tax Cuts and Jobs Act of 2017 introduced changes to Section 168, including the ability to take 100% bonus depreciation on qualifying property in the year it is placed in service. This means that businesses can deduct the entire cost of qualified property in the year it is acquired and placed in service, rather than depreciating it over several years. Section 168 also includes rules for determining the cost basis of the property and for making adjustments to the basis for changes in the use of the property. The Section 168 deduction can provide businesses with significant tax savings and improve cash flow.
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Section 168 deduction explained
Section 168(k) of the Internal Revenue Code (IRC) provides for a type of accelerated depreciation known as bonus depreciation. Bonus depreciation allows businesses to deduct a portion of the cost of qualified property in the year it is placed in service, rather than spreading out the deductions over several years. Under Section 168(k), businesses may take a bonus depreciation deduction equal to 100% of the cost of qualified property acquired and placed in service after September 27, 2017, and before January 1, 2023. This means that businesses may immediately write off the entire cost of eligible assets in the year they are placed in service.
To be eligible for bonus depreciation, the property must meet the following requirements:
- The property must be qualified property, which generally includes tangible property with a recovery period of 20 years or less, computer software, water utility property, and qualified film, television, and live theatrical productions.
- The property must be new, meaning it has not been previously used by the taxpayer or anyone else.
- The property must be acquired and placed in service after September 27, 2017, and before January 1, 2023.
- The taxpayer must have a basis in the property for depreciation purposes, meaning the taxpayer must own the property or have a leasehold interest in it.
It is important to note that some limitations may apply to bonus depreciation. For example, the amount of the deduction may be reduced if the taxpayer has insufficient taxable income or if the property is not used primarily for business purposes.
168(k) bonus depreciation phase-out
The bonus depreciation percentage under Section 168(k) is set to gradually phase out over time, with a reduction in the percentage each year until it is completely phased out after 2026, this is based on the Tax Cuts and Jobs Act (TCJA) which gradually reduces the bonus depreciation percentage yearly starting from 2023. The phase-out schedule is as follows:
- For property placed in service after September 27, 2017, and before January 1, 2023, the bonus depreciation percentage is 100%.
- For property placed in service during 2023, the bonus depreciation percentage is reduced to 80%.
- For property placed in service during 2024, the bonus depreciation percentage is reduced to 60%.
- For property placed in service during 2025, the bonus depreciation percentage is reduced to 40%.
- For property placed in service during 2026, the bonus depreciation percentage is reduced to 20%.
- For property placed in service after December 31, 2026, bonus depreciation is no longer available.
It is important to note that the phase-out schedule applies to the placed-in-service date, not the date of purchase or acquisition. Therefore, if a taxpayer acquires property before the end of 2022 but does not place it in service until after 2022, the bonus depreciation percentage will be reduced according to the above schedule. Additionally, some special rules apply to certain long-production-period properties and certain aircraft. Hence, it may be necessary to consult with a tax professional to determine how the phase-out rules apply to your specific situation.
Read about: How to calculate bonus depreciation
What assets are eligible for 100% bonus depreciation?
Generally, the following are eligible for 100% bonus depreciation:
- Qualified improvement property (QIP) which include any interior improvement to a nonresidential building that is placed in service after December 31, 2017, and may include improvements to heating, ventilation, and air conditioning (HVAC), roofing, and security systems, among others.
- New or used tangible personal property with a recovery period of 20 years or less. This may include machinery, equipment, furniture, and fixtures.
- Certain specified plants such as orchards and vineyards may be eligible for bonus depreciation.
- Certain film, television, and live theatrical productions. These productions may be eligible for bonus depreciation if specific criteria are met.
It is important to note that some assets may be partially eligible for bonus depreciation, and certain limitations may apply. Thus, taxpayers should consult a tax professional for guidance on their specific situation.
Is purchased software eligible for 100 bonus depreciation?
If the software meets these requirements, it may be eligible for 100% bonus depreciation in the year it is placed in service. However, there are certain limitations and exceptions that may apply, so it is essential to consult with a tax professional to determine whether the software qualifies for bonus depreciation and how to properly claim the deduction.
Read about: How does bonus depreciation work?
Differences between Section 168 vs 179
Section 168 and Section 179 are two different sections of the U.S. Internal Revenue Code (IRC) that provide different rules for businesses to deduct the cost of certain types of assets they acquire for use in their trade or business. Below, we shall consider some differences between these sections of the IRC.
- Section 168 covers the depreciation of tangible property, such as machinery, equipment, and buildings, while Section 179 covers the expense of tangible personal property, such as furniture, fixtures, and equipment, as well as certain software and qualified real property.
- Section 168 allows businesses to recover a certain percentage of the cost of the assets in the year it is placed into service, while Section 179 allows businesses to deduct the total cost of the asset in the year it is placed in service, up to a certain dollar amount. This means that the maximum amount that can be expensed under Section 179 is significantly lower than under Section 168. For tax years beginning in 2023, the maximum amount a taxpayer can expense under Section 179 is $1,160,000, while the maximum amount of bonus depreciation under Section 168 is 80% of the cost of the qualified property.
- The types of property that qualify for Section 179 expensing are generally more limited than the types of property that qualify for bonus depreciation under Section 168. For example, under Section 168, qualified improvement property is eligible for bonus depreciation while under Section 179, qualified real property is limited to certain improvements to nonresidential real property.
- Unused bonus depreciation cannot be carried over, while any unused Section 179 deduction can be carried forward to future tax years.
- Section 168 deduction is generally mandatory for the qualified property while Section 179 is an elective deduction.
Overall, Section 168 provides more generous depreciation allowances over the useful life of an asset, while Section 179 provides a more immediate deduction for the cost of acquiring certain types of property. The section to use will depend on each business’s specific circumstances and financial goals.
Summary of the differences between Section 168 vs 179
| Comparison criteria | Section 168 | Section 179 |
|---|---|---|
| Scope | Depreciation | Expensing |
| Dollar limit | None | Applicable up to a certain amount |
| Qualified property | Qualified improvement property, new or used tangible personal property, certain specified plants, and certain film, television, and live theatrical productions. | Unused deductions cannot be carried over |
| Nature | Generally mandatory | Elective |
| Carryover | Unused deductions cannot be carried forward to future tax years | Unused deduction can be carried forward to future tax years |
| Deductible amount in 2023 | Upto 80% | $1,160,000 |
Read about: Can you take bonus depreciation on rental property?
Conclusion
Section 168 deduction allows businesses to accelerate the depreciation of eligible assets by allowing for the immediate write-off of the entire cost of qualified property in the year it is placed in service. This allows businesses to increase their cash flow while reducing their tax liability in the year that a qualified asset is put in service. The rules governing this tax incentive are complex, and the gradual phase-out beginning in 2023 means that the amount of deduction will vary by year going forward.
Therefore, it is important to understand the rules and limitations surrounding this deduction, as well as any changes made to the law. Businesses should consult with a tax professional to determine their eligibility, ensure they are correctly calculating depreciation deductions, and understand how to properly use and benefit from this deduction.
