Taxes can be a headache for businesses. The good news is that several tax deductions exist to help you reduce your taxable income and keep more of your hard-earned money. Three particularly popular options are 179D, Section 179 expensing and bonus depreciation. Unfortunately, even some experienced tax professionals get confused about the differences between these deductions! This article aims to clear up the confusion and help you understand when to consider each one.
What Is Section 179D?
Section 179D of the U.S. tax code is a tax deduction designed to incentivize energy-efficient design and improvements in commercial buildings. It allows eligible taxpayers to claim a deduction for some of the costs associated with installing qualifying energy-saving systems in their buildings.
Who Is Eligible for 179D?
Commercial Building Owners
If you own a commercial building and invest in energy-saving improvements, you may be able to claim the 179D deduction. This includes owners of office buildings, retail stores, manufacturing facilities, warehouses and more.
Designers of Tax-Exempt Buildings
Architects, engineers, contractors, energy consultants and other professionals who design energy-efficient systems for tax-exempt buildings are also eligible for the 179D deduction. Note that the building itself must be owned by these tax-exempt entities (federal, state or local governments, non-profits, religious or tribal organizations).
Qualifying Systems
179D focuses on three primary building systems:
- Interior lighting: Installing more energy-efficient lighting systems, such as LEDs and advanced lighting controls can qualify for the deduction.
- HVAC and hot water systems: Upgrading or replacing HVAC systems and hot water systems with more energy-efficient models may be eligible.
- Building envelope: Improvements to the building's exterior—including the roof, walls, windows, doors and insulation—that reduce energy consumption can also qualify.
Deduction Amount
The Inflation Reduction Act significantly increased the potential deductions allowed under 179D. It now follows a tiered system, starting at $0.50 per square foot for a 25% improvement in energy efficiency and increasing to $1.00 per square foot for a 50% or greater improvement against a baseline reference building. These base amounts can be further enhanced by adhering to optional labor standards, potentially reaching a maximum of $5.00 per square foot.
Key Points
- Permanence: The 179D deduction is a permanent incentive.
- New vs. retrofit: Both new construction projects and retrofits to existing buildings can qualify.
- Certification: Claiming the 179D deduction requires obtaining a third-party certification demonstrating that the energy-saving improvements meet the necessary standards established by ASHRAE.
What Is Section 179 Expensing?
Section 179 expensing allows businesses to immediately deduct the full purchase price of qualifying equipment, up to certain limits, in the year it's placed in service. Instead of depreciating the cost of equipment over its useful life (spreading the deduction over several years), Section 179 lets you take the whole deduction upfront.
What Types of Equipment Are Eligible for 179 Expensing?
Most types of tangible business property qualify, including:
- Machinery
- Computers and software
- Office furniture and equipment
- Vehicles (subject to some limitations)
Both new and used equipment generally qualify for Section 179 expensing, making it a flexible option.
Deduction Amount
The maximum amount you can deduct changes from year to year. For 2024, the limit is $1,220,000. Additionally, there is a phase-out threshold. If you purchase more than a certain dollar amount of equipment during the year (for 2024, that threshold is $3,050,000), your deduction amount will start decreasing dollar-for-dollar.
Key Points
- Stimulating investment: Section 179 is intended to encourage businesses to invest in new equipment and upgrade their operations.
- Significant tax savings: Claiming a large deduction in the year you buy equipment can substantially lower your tax bill.
- Planning is key: Understanding the annual limits and how the phase-out works is crucial for getting the most out of the Section 179 deduction.
What Is Bonus Depreciation?
Bonus depreciation is a powerful tax incentive designed to encourage businesses to invest in new equipment and assets. It allows businesses to deduct a significant portion of the cost of qualifying assets in the first year they're placed in service, rather than depreciating the cost gradually over the asset's typical lifespan.
What Types of Assets Are Eligible for Bonus Depreciation?
Bonus depreciation is primarily intended to incentivize investment in new equipment and technology. The IRS generally restricts it to qualifying new tangible property. There are, however, some exceptions for certain used assets.
Assets with longer expected useful lives are generally better candidates for bonus depreciation. Common examples include:
- Machinery and equipment used in manufacturing or production processes
- Heavy-duty vehicles like trucks and construction equipment
- Certain types of commercial real estate improvements, such as roof replacements or building envelope upgrades
- Components of single-family homes and multifamily properties that have undergone cost segregation
Deduction Amount
Previously, bonus depreciation allowed a deduction for 100% of the cost of qualifying assets in the year they were placed in service. This was a significant tax benefit, especially for expensive purchases. However, the Tax Cuts and Jobs Act established a phase-down schedule for bonus depreciation. Here's a simplified breakdown:
- 2023: 80% deduction
- 2024: 60% deduction
- 2025: 40% deduction
- 2026: 20% deduction
- 2027: 0% deduction (bonus depreciation expires)
It’s worth noting that a recently proposed tax bill may alter this phase-down schedule and potentially even bring back 100% bonus depreciation, but there are no guarantees that it will pass.
Key Points
- Encourages investment: Similar to Section 179, bonus depreciation is meant to stimulate business investment in new assets and upgrades.
- Best for large purchases: The upfront deduction provided by bonus depreciation can offer significant tax benefits, especially for expensive assets with a longer useful life.
- Temporary incentive: It's important to remember that the bonus depreciation percentage is decreasing and will eventually expire altogether. Businesses that can benefit from this incentive should consider it sooner rather than later.
When to Choose Which
Now that you understand the basics of 179D, Section 179 expensing and bonus depreciation, let's talk about when you might prefer one over the others:
- 179D is best for projects with a focus on energy-efficient improvements in commercial buildings. If you're planning a new build or making energy-saving retrofits, 179D can lead to substantial tax deductions.
- Section 179 is best for a wide range of business equipment purchases. Its versatility and the inclusion of used equipment make it a go-to option for immediate deductions on the things your business needs.
- Bonus depreciation is best for large investments in new, long-life assets. When you're considering a major purchase, bonus depreciation can offer the biggest upfront deduction, especially while the percentage remains higher.
Of course, these are just general guidelines. The best tax strategy for you will depend on your specific circumstances, the assets you're purchasing and how they fit into your overall business picture.
Final Thoughts
Always remember that tax laws are subject to change, and your specific situation will impact which deductions are most advantageous. It's essential to consult with a qualified tax advisor to develop the best strategy for your business. That’s where Engineered Tax Services (ETS) comes in.
We have extensive experience in helping businesses claim every deduction they’re entitled to. By providing 179D evaluations, cost segregation studies and other specialty tax services, we uncover hidden deductions to optimize financial strategy.
For more information on these and other business deductions, contact us today for a free consultation.
