Bonus Depreciation for Dentists Restaurants and Gas Stations Explained
Introduction to Bonus Depreciation
Bonus depreciation is a powerful tax incentive that allows businesses to deduct a significant portion of the cost of qualifying property in the year it is placed in service. Governed by Code Sec. 168(k), this additional first-year depreciation deduction is designed to encourage investment in business assets. It counts toward accumulated depreciation, which reduces the asset's basis for determining gain or loss upon sale, and it is subject to section 1245 recapture rules. Bonus depreciation applies to personal property and certain leasehold improvements, rather than real property, making it a key consideration for businesses investing in equipment, machinery, and other tangible assets.
Bonus Depreciation vs Section 179
While both bonus depreciation and Section 179 offer valuable tax benefits by allowing businesses to deduct the cost of qualifying assets, they often complement each other rather than being mutually exclusive options. Businesses typically apply Section 179 to the maximum allowable amount first and then use bonus depreciation on the remaining cost of the property. This combined approach maximizes immediate tax benefits.
Key differences might make bonus depreciation particularly attractive for many businesses. Unlike Section 179, which has an annual dollar limitation on the amount that can be deducted, bonus depreciation allows for the deduction of a percentage of the cost of qualifying property in the year it is placed in service, with no dollar limit.
Another significant advantage of bonus depreciation is its flexibility regarding taxable income limitations. Section 179 deductions are limited to the taxable income of the business, meaning they cannot create or increase a net operating loss (NOL). In contrast, bonus depreciation can be used to offset taxable income entirely and even create an NOL, which can then be carried forward to offset taxable income in future years. This capability provides a valuable tax planning tool, enhancing cash flow and financial flexibility for businesses.
Applicable Percentage
The Tax Cuts and Jobs Act (P.L. 115-97) significantly altered the bonus depreciation landscape. For property acquired after September 27, 2017, and placed in service before January 1, 2023, the bonus rate was increased from 50-percent to 100-percent. Post-2022, the 100-percent bonus rate phases out by 20-percent annually:
- 80-percent for property placed in service in 2023
- 60-percent for property placed in service in 2024
- 40-percent for property placed in service in 2025
- 20-percent for property placed in service in 2026
These phased reductions highlight the importance of strategic planning in asset acquisition and placement to maximize tax benefits.
Acquisition Date and Property Qualification
The timing of property acquisition and placement in service is crucial for maximizing the benefits of bonus depreciation. As of tax year 2024, the bonus depreciation rate is 60 percent for property placed in service during the year.
To qualify, the property must have been acquired after September 27, 2017. For property acquired under a binding contract before September 28, 2017, it does not qualify for the current bonus depreciation rates. For self-constructed property, the acquisition date is determined by the start of construction (Reg. §1.168(k)-2(b)(5)).
To qualify for bonus depreciation, the property must be classified as Modified Accelerated Cost Recovery System (MACRS) property with a recovery period of 20 years or less. This includes certain computer software, specified plants, water utility property, and qualified films, television shows, and theatrical productions (Code Sec. 168(k)(2)).
Original Use Requirement
The original use of the property must commence with the taxpayer. However, for property acquired after September 27, 2017, the original use can either commence with the taxpayer or the property can be used if acquired from an unrelated taxpayer by purchase within the meaning of Code Sec. 179. This flexibility allows businesses to benefit from bonus depreciation on both new and used qualifying assets.
Computation of Bonus Depreciation
The bonus depreciation deduction is calculated based on the cost of the property, reduced by any portion expensed under Code Sec. 179. For replacement property received in a like-kind exchange or involuntary conversion, the entire adjusted basis of the replacement property qualifies for bonus depreciation if the original use of the replacement property begins with the taxpayer (Reg. §1.168(k)-2(g)(5); Reg. §1.168(k)-1(f)(5)).
Consider a business with an income of $600,000, acquiring equipment for $2,000,000 in 2024. This example will show how Section 179 and bonus depreciation interact, considering income limitations.
Section 179 Deduction:
For 2024, the maximum Section 179 deduction limit is $1,160,000. However, the Section 179 deduction cannot exceed the taxable income of the business. In this case, the business has an income of $600,000, so the Section 179 deduction is limited to $600,000.
Remaining Cost:
After applying the Section 179 deduction, the remaining cost of the property is $2,000,000 - $600,000 = $1,400,000.
Bonus Depreciation:
The business then applies bonus depreciation to the remaining cost of $1,400,000. For 2024, the bonus depreciation rate is 60 percent. The bonus depreciation deduction would be 60 percent of $1,400,000 = $840,000.
Total Deduction in 2024:
Section 179 Deduction: $600,000 (limited by income)
Bonus Depreciation Deduction: $840,000
Total Deduction: $600,000 + $840,000 = $1,440,000
Impact of Income Limitation:
Income Limitation: The Section 179 deduction is limited to the business's taxable income, which in this case is $600,000.
Bonus Depreciation Flexibility: Unlike Section 179, bonus depreciation is not limited by taxable income and can be used to create or increase a net operating loss (NOL).
In this scenario, the business's total first-year deduction of $1,440,000 is a combination of the maximum Section 179 deduction limited by the income and the bonus depreciation. This total deduction exceeds the business's income, creating a net operating loss that can be carried forward to offset future taxable income, providing substantial tax savings in subsequent years. By combining Section 179 and bonus depreciation, businesses can maximize their immediate tax benefits even when income limitations are considered, enhancing cash flow and financial flexibility.
Election Out
Taxpayers have the option to elect out of bonus depreciation for any class of MACRS property placed in service during the tax year (Code Sec. 168(k)(7)). To do this, the taxpayer must include a statement with their timely filed return (including extensions) indicating the election not to claim bonus depreciation for the specified class of property. This option provides flexibility for taxpayers to manage their depreciation deductions in a manner that best suits their financial strategies.
Property Qualifying for Bonus Depreciation
Dentists
Dentists often invest in various types of property that may qualify for bonus depreciation. These can include:
- Dental Equipment: High-cost items such as X-ray machines, dental chairs, and sterilization equipment are often eligible for bonus depreciation. These assets typically have a recovery period of 20 years or less, making them qualified property under MACRS.
- Computer Software: Specialized dental software used for patient management, billing, and imaging can qualify for bonus depreciation.
- Office Furniture and Fixtures: Desks, chairs, filing cabinets, and other office furniture used in a dental practice can be depreciated using bonus depreciation.
- Leasehold Improvements: Any improvements made to a leased office space, such as new lighting, partitions, or flooring may qualify, provided they meet the specific requirements set forth under Code Sec. 168(k).
Restaurants
Restaurants can also benefit significantly from bonus depreciation by deducting the cost of various assets in the year they are placed in service:
- Kitchen Equipment: Items like ovens, refrigerators, freezers, and dishwashers often qualify for bonus depreciation due to their relatively short recovery periods.
- Point of Sale (POS) Systems: POS systems and related software used for order processing, billing, and inventory management can be depreciated using bonus depreciation.
- Furniture and Fixtures: Tables, chairs, booths, and bar equipment used in the dining area typically qualify for bonus depreciation.
- Leasehold Improvements: Renovations such as new lighting, flooring, or even extensive remodeling of the dining area, kitchen, or restrooms can qualify as long as they meet the criteria under Code Sec. 168(k).
Gas Stations
Gas stations often have substantial investments in property that can be eligible for bonus depreciation:
- Fuel Pumps: The cost of fuel pumps and related dispensing equipment can be depreciated using bonus depreciation.
- Tanks and Piping: Underground storage tanks and piping systems used for fuel storage and distribution are often eligible for bonus depreciation.
- Convenience Store Equipment: Items such as refrigerators, freezers, shelving, and cash registers used in the convenience store section of the gas station can qualify.
- Signage: Exterior signage, including digital signs and canopy signs, used to display fuel prices and brand information, may be eligible for bonus depreciation.
- Leasehold Improvements: Improvements to the gas station property, such as new lighting, paving, or canopies may qualify if they meet the requirements set forth under Code Sec. 168(k).
Conclusion
Bonus depreciation offers substantial tax benefits by allowing businesses to accelerate depreciation on qualifying assets. Understanding the nuances, including applicable percentages, acquisition dates, property qualifications, and the ability to elect out, is essential for maximizing these benefits. Strategic planning around the timing of asset acquisition and placement in service can significantly impact a business's tax liability, providing a powerful incentive for continued investment in growth and development.