Manufacturing is a capital-intensive industry, making it essential for manufacturers investing in equipment, plant improvements or other depreciable property, to take full advantage of available tax incentives. This blog reviews Section 179 expensing and bonus depreciation. A sidebar details three potential tax pitfalls to be aware of with utilizing Sec. 179 expensing and bonus depreciation.

Sec. 179 expensing

Under Sec. 179, manufacturers are allowed to deduct 100% of the cost of qualifying assets in the first year they are placed in service rather than writing off those costs over several years (with certain limitations discussed below). Qualifying assets include most business equipment, machinery and office furniture, vehicles, and off-the-shelf computer software. Used assets may also qualify if they are purchased by the business during the tax year.

Qualified improvement property (QIP) is also eligible for Sec. 179 expensing. QIP refers to certain improvements to the interior of an existing commercial building, such as the installation or replacement of drywall, ceilings, interior doors, fire protection, mechanical, electrical and plumbing. However, improvements attributable to elevators or escalators, the building’s internal structural framework, or enlargement of the building are not considered QIP and therefore not eligible for Sec. 179.

Sec. 179 expensing has limitations:

• Annual cap ($1.25 million in 2025).
• gradual phase out at certain spending levels. Dollar-for-dollar reduction of annual allowance for qualifying assets purchased over certain levels ($3.13 million in 2025).
  • Example: $4 million spent on qualifying purchases in 2025: $4 – $3.13 = $870,000 reduction of Sec. 179 expense.  The adjusted Sec.179 expense = $1.25 cap less $870,000.  The deduction for 2025 is now only $380,000.
• Deduction is eliminated at $4,380,000 for the 2025 tax year.
• Deduction cannot exceed taxable income for the year.
• Carryforward and bonus depreciation (discussed below) are allowed.

Bonus depreciation

Bonus depreciation is another option for deducting the cost of equipment, machinery, furniture, vehicles, off-the-shelf software and QIP (including certain used property). Under the Tax Cuts and Jobs Act (TCJA) provision, bonus depreciation was allowed for up to 100% of the cost of qualifying property when first introduced. The TCJA has since been modified to reduce bonus depreciation to:

• 80% for property placed in service in 2023;
• 60% for 2024; and
• 40% for 2025.

Unless Congress changes the law, bonus depreciation will be reduced to 20% in 2026 and then eliminated altogether for property placed in service after 2026.

Using both incentives in the same year

It is possible to claim both Sec. 179 expensing and bonus depreciation in the same year as long as they are applied to different costs.  Manufacturers typically maximize the Sec. 179 expensing election before claiming bonus depreciation. This is because Sec. 179 expensing offers greater flexibility: it allows businesses to selectively choose which assets to expense. In contrast, bonus depreciation must taken for all asset purchases that fall into a given class.

Consider a cost segregation study

If you are acquiring, constructing or substantially improving a manufacturing facility, a cost segregation study can generate significant tax savings. These studies identify costs that can be reclassified into asset classes with shorter depreciable lives. This, in turn, accelerates regular depreciation deductions and can also enhance the benefits of Sec. 179 expensing and bonus depreciation.

For example, commercial property is usually depreciated over a lengthy 39-year period. However, certain property components may be classified as five-, seven-, or 15-year property, making them eligible for accelerated depreciation methods. IRS regulations generally define “personal property” as tangible depreciable property other than buildings and their structural components.

Look at the big picture

Sec. 179 expensing and bonus depreciation can offer substantial tax benefits. However, it is important to evaluate these benefits within the context of your overall tax strategy, including state-specific rules.  In some cases, it may make sense to opt out of Sec. 179 expensing or bonus depreciation to maximize the benefits of a state investment tax credit. Contact your tax advisor for more information.

Sidebar: Beware of potential tax pitfalls

Despite the significant potential benefits of Section 179 expensing and bonus depreciation, forgoing these benefits may sometimes be a better strategy. In some situations, Sec. 179 expensing or claiming bonus depreciation can lead to tax traps. Consider the following examples:

Potential Sale of a Building with Qualified Improvement Property (QIP)
Expensing or claiming bonus depreciation on QIP may cost you. The gain attributable to these deductions will be taxable at ordinary income tax rates up to 37, Alternatively, any long-term gain attributable to assets depreciated under regular depreciation rules will be taxed at a top federal rate of 25%.

Claiming a QBI (qualified business income) Deduction
This deduction generally allows eligible pass-through entities – such as partnerships, limited liability companies or sole proprietorships – to deduct up to 20% of QBI. Since the deduction is limited to 20% of your taxable income, increasing expenses will impact the ability to fully claim QBI deductions. You may end up benefiting by only 80% of the QBI deduction.

Anticipating Higher Future Tax Rates
If you expect your tax rate to increase or move into a higher tax bracket, depreciation deductions may be more valuable in the future. It may be advantageous to forgo first-year expensing or bonus depreciation and deferring those write-offs to years when they will be most beneficial.

For more information, contact Joyce Carlson at [email protected] or 312.670.7444. Visit ORBA.com to learn more about our Manufacturing and Distribution Group. Sign up here to receive our blogs, newsletters and Client Alerts.