Scenario: Choosing Between Section 179 and Bonus Depreciation

This page describes a composite hypothetical. It is not a real client or a real result. Amounts are assumptions, and deduction limits and bonus percentages change with legislation, so confirm current rules before relying on anything here.

The Scenario in Brief

A machining business is buying new equipment for 250,000 dollars in the fall. The owner asks an advisor how the cost will be deducted and whether to use Section 179 expensing, bonus depreciation, or regular depreciation. The advisor walks through the factors that would drive the choice.

Assumptions Used

• Equipment cost: 250,000 dollars, all 7-year property, placed in service in October.
• The business is an S corporation with taxable income before the equipment deduction of 400,000 dollars this year.
• Next year's projected taxable income is 250,000 dollars.
• The owner assumes a 32 percent marginal federal rate this year and 24 percent next year. These are flat assumptions for arithmetic.
• The state does not follow federal bonus depreciation but allows Section 179 up to a lower limit.

The Options

Section 179. The business elects to deduct the cost of qualifying property in the year it is placed in service, up to an annual limit and subject to an income limit. Since the equipment cost is 250,000 dollars and business income is 400,000 dollars, the deduction would generally be allowed in full if the limits permit.

Bonus depreciation. Bonus depreciation applies automatically unless the business elects out for the class of property. With a bonus percentage of 100 percent, the whole cost would be deducted in the year. If the applicable percentage is lower, the remaining cost would be depreciated over the normal recovery period.

Regular depreciation. If the business elected out of bonus depreciation and did not elect Section 179, the cost would be depreciated over seven years under the applicable schedule, with a first-year rate around 14 percent under the half-year convention.

Worked Arithmetic: Timing of Deductions

Under full expensing, taxable income in year one falls from 400,000 to 150,000 dollars. At an assumed 32 percent marginal rate, the federal tax reduction in year one is about 80,000 dollars, compared with about 11,400 dollars under regular depreciation. Under regular depreciation, some deductions come later at an assumed 24 percent rate. The total deductions over the life are the same, so the comparison is about timing and rate, not about a larger total. These figures are assumptions and ignore the qualified business income deduction, state tax, and other items.

State Conformity

Because the assumed state does not follow bonus depreciation but allows a limited Section 179 amount, the state deduction would be smaller than the federal one, and the owner would add back the difference on the state return. The advisor would model the state effect and would consider using Section 179 to the extent the state allows, with bonus depreciation on the balance, so that the federal and state results are both reasonable.

Future-Year Planning

If the owner expected higher income next year, spreading deductions could be attractive. In this scenario, income is expected to fall, so taking the deduction now, at the higher assumed rate, looks more favorable. The advisor would also discuss the effect on the qualified business income deduction, since a large equipment deduction lowers qualified business income and could reduce that deduction in the year.

Recapture

The advisor would mention that gain on a later sale of the equipment is generally ordinary income up to the depreciation taken. That is a reason to consider how long the equipment will be used and how it will be disposed of.

Scenario Variations Worth Considering

If the equipment were placed in service in January of the next year instead of October of this year, none of the deduction would fall in this year. If the business had a smaller income, the Section 179 income limit could restrict the deduction, while bonus depreciation would not be limited by income. If the equipment cost exceeded the Section 179 limit, bonus depreciation would apply to the balance.

Risks and Limits

• The purchase should make business sense before tax is considered.
• Limits and percentages differ by year and should be confirmed.
• State rules can reduce the benefit.
• Recapture on sale can reduce the long-term benefit.

What This Scenario Teaches

Expensing accelerates deductions. It does not add deductions. The choice depends on current and future income, state conformity, and the owner's plans for the equipment.

Questions to Bring to Your Advisor

1. What limits and percentages apply for my year?
2. How does my state treat each option?
3. How will the deduction affect the qualified business income deduction?
4. When will the equipment be placed in service?

Educational purposes only. This page is an illustrative educational scenario, not tax, legal, or accounting advice, and it does not describe a real client or a real result. Tax laws change and outcomes depend on individual facts, so consult a qualified professional before acting. No result is guaranteed.