Depreciation Changes 2022 vs. 2023

By Marissa Mamet December 28, 2022

It’s hard to believe that the 2022 year is coming to an end and 2023 will shortly be upon us.  As we move forward into the New Year, there are a couple of items surrounding depreciation that can be easily overlooked.

Bonus Depreciation in 2023: Phasing-Out

Bonus Depreciation has been a concept that has been around for more than 20 years. It allows for accelerated depreciation in the first year the qualified property is placed into service by a business instead of taking depreciation over the assets’ useful life.

The Tax Cuts and Jobs Act of 2017 increased bonus depreciation by allowing 100% of the depreciation of eligible property to be taken in the first year for assets acquired and placed in service after September 27, 2017 through December 31, 2022.  Eligible property includes property used by a business for at least 50% of the time and that has a useful life of 20 years or less when calculating depreciation under the Modified Accelerated Cost Recovery System (MACRS).  Common examples of eligible property include vehicles, furniture, fixtures, machinery, land improvements, qualified improvement property, and computer software.  Common examples of property that is not eligible for bonus depreciation include buildings and land.

Beginning January 1, 2023, bonus depreciation allowed in the first year the eligible property has been placed into service will drop to 80%, with the remaining 20% to be spread over the useful life of the asset.  Bonus depreciation allowed in the first year of service will continue to decrease by 20% until 2027, when bonus depreciation will be completely phased out.

• 100% bonus depreciation for eligible assets placed in service during the 2022 calendar year
• 80% bonus depreciation for eligible assets placed in service during the 2023 calendar year
• 60% bonus depreciation for eligible assets placed in service during the 2024 calendar year
• 40% bonus depreciation for eligible assets placed in service during the 2025 calendar year
• 20% bonus depreciation for eligible assets placed in service during the 2026 calendar year
• 0% bonus depreciation for eligible assets placed in service during the 2027 calendar year

Although bonus depreciation is phasing out over the next five years, there are a host of other avenues available for taxpayers to continue to accelerate depreciation.

One of those avenues is taking advantage of Section 179.  Section 179 allows for expensing the cost of eligible property in the first year the property is placed in service.  During 2022, the maximum deduction allowed under Section 179 is $1,080,000.  The deduction is reduced dollar for dollar for equipment purchases in excess of $2,700,000, with a complete phase out once equipment purchases reach $3,780,000.  During 2023, these numbers increase for a maximum deduction allowed under Section 179 of $1,160,000 unless equipment purchases are in excess of $2,890,000.  In that case, the deduction will be reduced dollar for dollar until fully phased out when equipment purchases reach $4,050,000.  The taxpayer must also have taxable income in order to benefit from the Section 179 deduction.

The Section 179 deduction can be limited for taxpayers if their equipment purchases exceed those thresholds or the taxpayer does not generate taxable income.  There are other avenues that can be explored that are typically most beneficial for a taxpayer who recently purchased a building or undertook a large renovation project.  These include cost segregation studies and exploring energy efficient rebates, deductions, and credits that have become more popular with the help of the Inflation Reduction Act (IRA) of 2022 signed into law mid-August 2022.

Cost segregation studies are performed by specialized advisors to assist taxpayers who are purchasing buildings or experiencing large renovations to carve out assets with shorter lives from the building.  Depending on the size of the project, this can be a particularly valuable tool to accelerate depreciation.

The Inflation Reduction Act (IRA) of 2022 released a multitude of green energy initiatives, which also provided energy efficient rebates, deductions & credits for substantial improvements.  For an in-depth discussion of these updates, see our articles on Winners of the Inflation Reduction Act Part 1 and Part 2.

Outside of accelerating depreciation, it is imperative to confirm the treatment of the expenditure. Back in 2015, the Internal Revenue Service provided additional guidance for expenditures that can be treated as routine maintenance expenses under the Tangible Property Regulations, which should continue to be on the forefront while undergoing upgrades and renovations.  For a more detailed discussion, see our recent article on the topic: Tangible Property Regulations Continue to be Applicable.

Depreciation Impacts on Section 163(j) Business Interest Expense Limitation

Rules and regulations surrounding depreciation have and will continue to evolve in a variety of ways beyond just bonus depreciation that is highlighted above.  Not only is accelerated bonus depreciation decreasing in 2023, but those taxpayers subject to the business interest expense limitation will also need to consider another matter starting with 2022 calculations.  Beginning in tax year 2022, depreciation, amortization and depletion will no longer be added back to calculate adjusted taxable income.

Taxpayers with average annual gross receipts in excess of $27 million in 2022 ($29 million in 2023) are subject to testing business interest expense to determine the limitation.  In general, interest expense is limited to 30% of adjusted taxable income.  Beginning with tax year 2022, depreciation, amortization and depletion will no longer be added back to calculate adjusted taxable income.  Without this adjustment, taxpayers may be caught off guard with a lower adjusted taxable income and therefore a higher disallowed interest expense (and therefore higher taxable income).  The disallowed interest expense is carried forward until released.

It is essential for taxpayers to recalculate average annual gross receipts every tax year to confirm that they are indeed subject to the business interest expense limitation. Taxpayers with less than $27 million in 2022 ($29 million in 2023) are exempt from testing business interest expense (other than tax shelters).  Keep in mind that the test for average annual gross receipts becomes more complicated when there are multiple businesses that are related to each other.

For those taxpayers over $27 million in 2022 ($29 million in 2023) of average annual gross receipts, there are exemptions for certain dealerships with floor plan financing and certain regulated public utilities or cooperatives. Other businesses may be eligible to make an irrevocable real property trade or business or farm trade or business election. If the business qualifies and decides to make one of these irrevocable elections, the business will be relieved from testing the interest expense and from any potential limitation.  However, certain property would now be depreciated under the Alternative Depreciation System (ADS).  These assets will have a longer depreciable life and not be eligible for bonus depreciation.  For example, if the real property trade or business election is made, a residential rental property of 27.5 years under MACRS would transition to 30 years under ADS and a non-residential building of 39 years under MACRS would transition to 40 years under ADS.  Additionally, Qualified Improvement Property would transition from 15 years under MACRS to 20 years under ADS and it would not be eligible for any additional first year bonus depreciation.

For a more detailed discussion on the Section 163(j) calculation, see our article: New Limitation on Interest Deductions for Businesses.

Conclusion

Taxpayers should take advantage of bonus depreciation while they still can but also review the implications that accelerating depreciation may have in other applicable areas. To complicate the matter further, it is worth noting that each state has its own rules surrounding the above issues and taxpayers have their own unique individual situations.  There may be additional factors to consider that are outside the scope of this article, such as loss limitations, which we covered in an earlier article. As always, taxpayers should consult their advisors to review their specific circumstances to determine their best course of action.