This article will discuss Bonus Depreciation and Section 179 Expense as it applies to personal property purchases of Real Estate Agents and small business owners. To learn how Bonus Depreciation and Section 179 Expense impact automobiles, please read our article Auto Expenses – Bonus Depreciation and Section 179 Expense. We also cover these topics in detail in our Real Estate Agent, Tax Cut Library.
As mentioned in all of our depreciation-related articles – we only cover the basics of depreciation-related topics, including Bonus Depreciation and Section 179 Expense. We do this for two reasons. First; Deprecation is highly complex. There are so many methods and rules that the IRS Publication 946 - How to Depreciate Property is 114 pages long (and it only covers the basics)! The second reason is the frequency with which congress changes depreciation rules. This penchant for change helps keep tax professionals gainfully employed, but it does little to keep depreciation articles, such as this one, timely & correct.
Overview & Early Warning
Overview: Bonus Depreciation and Section 179 Expense are valuable tools that allow businesses to expense higher portions of assets than regular depreciation allows. Many members of Congress encourage the early expensing of assets because they believe the tax-savings boosts economic growth and more significant investment. Common sense reveals the truth of this belief, at least in the short-term. Taxes saved by immediately deducting an asset’s cost is a powerful incentive to make the purchase.
Warning: Carefully weigh the pros and cons of making an expensive asset purchase before doing so. Tax-cutting should not be the primary motivator. On many (too many) occasions, I have witnessed business owners purchase assets solely to reduce their taxes, often going into debt to do so. A builder, for example, may finance a backhoe near the end of the year to reduce his tax liability. The purchase cuts his taxes for the year, but the backhoe is only used a few times per month after that. It does not generate enough revenue to cover its loan payment and maintenance costs. Cash flow problems soon follow.
Moreover, the backhoe is fully expensed and generates no future tax deductions. The result: Higher tax bills each consecutive year with less cash to pay for it. Not a great place for an owner to be.
The first asset-expensing tool is Bonus Depreciation, also called the Special Depreciation Allowance. Bonus Depreciation allows (actually requires) the taxpayer to depreciate a certain percentage of qualifying property placed in service during the year. From 2018 through 2022 the Bonus Depreciation percentage rate is 100%, unless – of course – congress changes it before 2022. One hundred percent Bonus Depreciation means all of an asset’s cost is deducted in the year of purchase.
Qualifying assets: Most assets purchased by real estate agents for business use will qualify for Bonus Depreciation. Common Qualifying property includes:
- Tangible property depreciated under MACRS (Modified Asset Costs Recovery System) with a recovery period (class life) of 20 years or less. For a list of asset life classes as our article on depreciation.
- Off-the-shelf computer software.
- Qualified Improvement Property – improvements made to the interior of nonresidential real property after the date the building was placed in service as long as they do not enlarge the structure. Elevators, escalators, or improvement to the building’s internal structural framework are also not qualified improvement property. (Note: Although congressional intent was to have qualified improvement property qualify for Bonus Depreciation and Section 179 expensing, a technical drafting error in the Tax Cuts and Jobs Act, failed to do so. A correction is needed.)
- Most Automobiles (with limits).
In short, most business assets purchased by a real estate agent (such as computers, sale signs, tablets, cameras, and similar items) qualify for Bonus Depreciation. Limits on vehicle depreciation, however, means that many vehicles are not eligible for 100% Bonus Depreciation. We discuss bonus limitations in our article, Real Estate Agents - Auto Expenses: Bonus Depreciation and Section 179 Expense. Also, assets purchased and sold during the same year do not qualify for Bonus Depreciation.
It is also important to note that “listed property” (most vehicles and items often used for recreation or amusement such as cameras and video equipment) must be used more than 50% for business to qualify for business depreciation. Also, if business use of listed property falls below 50%, a portion of the Bonus Depreciation claimed on the property must be included in income (recaptured).
Used Items Now Qualify: Before the passage of the Tax Cut and Jobs Act of 2017, only new assets qualified for Bonus Depreciation. After September 28, 2017, however, many used items now qualify for Bonus Depreciation. Qualifying assets must be purchased for business use and be new to the buyer. Personal use items converted to business use are also eligible for Bonus Depreciation if purchased after September 28, 2017. For more information on personal-use assets converted to business use, please see our article on the converted property.
Bonus Depreciation Mandatory: Utilizing Bonus Depreciation is mandatory unless the taxpayer elects out of it by attaching a statement to their tax return. Opting out of Bonus Depreciation is done by depreciable class, meaning that opting out must be done for all property with a particular class-life (for example, assets depreciated over five years, seven years, etc.). Certain circumstances make it financially beneficial to elect out of Bonus Depreciation. For example, when regular depreciation reduces the future years’ income tax at a higher marginal tax rate.
Section 179 Expense
Overview: Section 179 Expenserefers to Section 179 of the Internal Revenue Code, Election to Expense Certain Depreciable Business Assets. The 179 Expense allows business owners to deduct a desired amount of a qualified asset’s value in the year it is placed in service. Unlike Bonus Depreciation, the Section 179 Expense is not mandatory. The taxpayer elects the amount of the asset’s value they wish to expense. Businesses make the election on Part 1 of Form 4562Depreciation and Amortization. Once the election is the owner can revoke it on an amended return. Once revoked. However, it cannot be reinstated.
Section 179 cannot create a loss (discussed below). Any Section 179 Expense limited by loss is carried forward to the next tax year.
Qualifying Assets: An asset must be used more than 50% for business to qualify for Section 179 Expensing. If business use of any asset drops below 50% in any tax year, a portion of the 179 Expense previously claimed must be included in income (recaptured). New and used assets qualify for Section 179, but the assets must be purchased - personal assets converted to business use do not qualify for Section 179 expensing.
Most assets purchased by real estate agents qualify for the Section 179 Expense.
- Machinery, equipment, and furniture used in business.
- Off-the-shelf computer software.
- Assets used in residential rentals such as beds, furniture, and appliance.
- Portable air conditioners and portable heaters
- Nonresidential Real Property Assets: Certain improvements made to nonresidential real property, including roofs, heating, and air conditioner units, Fire alarms, and security systems. These items must be placed in service after the property is placed in service to qualify.
- Used property purchased by the business, but not personal-use property converted to business use.
- Automobiles (limits apply – see our article Real Estate Agents - Auto Expenses: Bonus Depreciation and Section 179 Expense).
Nonqualifying Assets: Some assets do not qualify for Section 179. Here is a brief list that may impact real estate agents:
- Investment Property, including most residential and nonresidential real estate.
- Land, land improvements, and most buildings.
- Properties purchased from related parties.
- Gifts and inheritances.
Deduction & Investment Limits: Albeit, these limits impact few small business owners and real estate agents; there are limits on the amount of the Section 179 expense a business can deduct. The deduction itself is limited to $1 million per year (for 2018 and 2019 & may change). There is also an annual investment limit – a ceiling on the total amount of Section 179 property placed in service during the tax year. Currently, this limit is $2.5 million. When asset cost exceeds this limit, the $1 million deduction limit is reduced one dollar for each dollar over $2.5 million until reaching zero.
Income Limit: Section 179 Expense cannot create a business-income loss. Business income, however, is broadly defined. For single and married taxpayers filing jointly, business income is the sum of the following:
- Net profits from all sole proprietorships (Schedule C’s) reported on the return before deducting Section 179 Expense and half of self-employment tax.
- Employee wages on the return.
- Ordinary pass-through income from partnerships and S corporations.
- Gains or Losses from the sale of most business assets.
Generally, any unused Section 179 Expense is carried over to the following year until used up.
Ordering of Section 179 Expense, Bonus Depreciation, and Regular Depreciation
The order of these deductions will impact very few real estate agents. It may, however, influence the investment decisions of larger businesses, most notably when the maximum Section 179 expense is reduced, or the Bonus Depreciation percentage is less than 100%.
Deductions occur in the following order: 1) Section 179 Expense, 2) Bonus Depreciation, and 3) Regular depreciation. For example, assume a business makes $1,150,000 of qualified asset purchases during the year. Under current rules, $1 million of the asset cost can be expensed under Section 179. One hundred percent of the remaining $150,000 is then written off as Bonus Depreciation. Because the asset is completely expensed, there is nothing left over to deduct via regular depreciation. The tax savings from this deduction? Over $400,000. Now, that’s some money to reinvest!
Take Away: Bonus Depreciation and the Section 179 Expense are outstanding, albeit complex, tax-cutting tools. Most equipment and machinery purchased by real estate agents qualify for either deduction. Like regular depreciation, Bonus Depreciation and the Section 179 Expense reduces asset basis (explained in our Article Real Estate Agents: Depreciation Expense) and must be tracked from year-to-year because the eventual sale, exchange or disposal of a depreciable asset may create a taxable gain or deductible loss. These complications are the reasons we recommend business owners and real estate agents hire a tax professional to prepare their tax returns.
Summary and Invite: We hope this article helped you to better-understand Bonus Depreciation and the Section 179 Expense as it applies to Real Estate Agents. If you’d like to learn more about cutting your most significant expense, TAXES, check out our Real Estate Agent Tax Cut Library. The Real Estate Agent Tax Cut Library includes over eight hours of video broken into twenty-nine searchable volumes and covers every possible deduction a Real Estate Agent can take on their tax return. Our Broker Version will help your entire agency cut their taxes! We also invite you to browse our courses.