Uncle Sam Wants to Assist Buyers of New and Used Machinery

Machinery buyers and sellers play crucial roles in our economy – they enable us to produce food, construct infrastructure like roads and buildings, and transport materials more efficiently. Investments in machinery significantly contribute to high productivity levels.

Recognizing the importance of capital investments in machinery and research and development, Congress provides favorable tax treatment for these areas. This support encourages continuous innovation and economic growth.

One such incentive is bonus depreciation, designed to motivate buyers of heavy machinery to keep their fleets modernized and efficient.

What Kinds of Purchases Qualify for Bonus Depreciation?

According to current IRS guidelines, qualified property under bonus depreciation includes tangible personal property with a recovery period of 20 years or less. Most heavy machinery purchases fall under this category, including tractors, harvesters, forklifts, excavators, bulldozers, cranes, aerial lifts, telescopic handlers, and more.

Used machinery purchases also qualify for bonus depreciation, provided the machinery wasn't previously owned by the buyer. The rules changed in 2017 to allow used machinery to be eligible for the benefit.

However, real estate improvements and land purchases don’t qualify. There are also specific limits for automobile purchases. Additionally, the updated tax law in 2017 shortened the recovery period for farming equipment from seven to five years for regular depreciation, though this doesn’t apply to grain bins, cotton ginning assets, fences, or other land-related improvements.

How Is Bonus Depreciation Calculated?

Depreciation spreads out the cost of long-term assets over their useful lives. Typically, businesses calculate this using a depreciation schedule, which assigns specific percentages to each year (e.g., 20% in Year 1, 15% in Year 2, etc.).

Companies using US GAAP accounting usually maintain two types of depreciation schedules: "book depreciation" and "tax depreciation." Book depreciation serves for financial reporting purposes and tends to be more evenly spread out. Managers and bankers often refer to this figure. Tax depreciation, however, follows different rules solely for tax purposes. Tax laws frequently change, allowing for accelerated depreciation methods.

In 2021, the calculation is straightforward: 100% of the qualifying asset's value can be claimed. Other incentives like Section 179 might alter this, but typically, tax advisors suggest maximizing the Section 179 deduction first before applying bonus depreciation to any remaining balance. Taxpayers can opt out of the extra first-year depreciation if desired, but this decision applies to all similar assets acquired in the same year.

What Is Bonus Depreciation in 2021?

At present, the bonus depreciation rate is set at 100% of the asset's value. This percentage fluctuates over time depending on changes in tax legislation. While the current rate is scheduled to decrease in the future, new laws could maintain the high rates. Congress typically revisits tax laws annually and makes adjustments accordingly.

Here’s the current bonus depreciation schedule according to the IRS:

Examples of Bonus Depreciation for New and Used Machinery Purchases

Example 1: Suppose you buy a used Caterpillar 301 mini excavator for $25,000. You haven’t owned it before, and it will be used for business purposes. In this case, the full $25,000 qualifies for bonus depreciation. Used equipment is eligible as long as it hasn’t been previously owned by the buyer and is used for business activities.

Example 2: You purchase a new HLA attachment worth $3,000 for your business. The entire amount qualifies for bonus depreciation. Attachments and other complementary items used with machinery also qualify.

Example 3: You buy a used John Deere 100 series lawn tractor for $1,200. It will be used 90% for your home and 10% for work. Since it’s primarily for personal use, this purchase doesn’t qualify for bonus depreciation.

Example 4: You acquire a used Volvo construction dozer for $60,000. Your business qualifies for Section 179, and you’ve already used Section 179 for the dozer. Therefore, you cannot claim bonus depreciation for this asset because you’ve chosen to use Section 179 instead.

Example 5: You purchase a used Peterbilt heavy-duty truck for $110,000. During the same year, you bought an International heavy-duty truck and opted not to apply bonus depreciation to the International vehicle. Since the two vehicles are similar and were purchased in the same year, you must treat them consistently. Consequently, the Peterbilt won’t qualify for bonus depreciation either.

How Does Bonus Depreciation Work with Section 179?

Both Section 179 and bonus depreciation are tools to reduce your tax liability, but they operate differently. Section 179 allows you to deduct the cost of qualifying purchases as an immediate expense rather than spreading it over time via depreciation. This distinction is vital for tax accounting—long-lived assets (like a tractor) are treated differently from consumable items (like DEF fluid).

Without Section 179 and bonus depreciation, businesses would typically depreciate long-term assets gradually. For instance, a $300,000 tractor might be depreciated over several years under standard IRS rules. Section 179 and bonus depreciation accelerate these deductions, providing tax savings sooner. Tax benefits received earlier are more valuable because they can generate returns through reinvestment.

In 2021, the similarity between Section 179 and bonus depreciation has increased due to the 100% bonus depreciation coverage. Previously, when the bonus depreciation rate was limited to 50%, the distinctions were more pronounced.

You can combine Section 179 and bonus depreciation in a single year. Generally, tax professionals advise maximizing the Section 179 deduction first, then applying bonus depreciation to any remaining balance.

Key differences between Section 179 and bonus depreciation include:

• Section 179 treats the cost as an expense, whereas bonus depreciation capitalizes the asset and depreciates it over time.
• Section 179 offers a fixed dollar deduction (capped at $1.05 million in 2021), while bonus depreciation allows a percentage-based deduction (with no cap).
• Section 179 targets smaller and mid-sized businesses (subject to limits on total qualifying purchases), whereas bonus depreciation has no such restrictions.
• Section 179 includes expenses for improving and upgrading real estate, while bonus depreciation excludes these.
• Section 179 provides greater flexibility in managing tax deductions—for instance, you can choose to defer part of the benefit into future years—but bonus depreciation requires full application to qualifying assets within the same category.

Important Note

We wrote this article to help you understand bonus depreciation and its implications for purchasing machinery. Please note that we’re not tax experts and cannot offer personalized tax advice. Always consult a certified tax professional for guidance tailored to your situation. Tax laws evolve, and interpretations change over time. Professionals stay updated on these developments to ensure compliance.

Resources

IRS Form 4562 for depreciation
How a business owner got a free truck

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