In this Edition
July 26, 2022

Businesses: Act Now to Make the Most Out of Bonus Depreciation

PODCAST: Step-Up in Basis at Death

Important Considerations When Engaging in a Like-Kind Exchange

A Tax Break for Educators Gets an Update

Medicare Premiums May Lower Your Taxes
Businesses: Act Now to Make the Most Out of Bonus Depreciation
The Tax Cuts and Jobs Act (TCJA) significantly boosted the potential value of bonus depreciation for taxpayers — but only for a limited duration. The amount of first-year depreciation available as a so-called bonus will begin to drop from 100% after 2022, and businesses should plan accordingly. 

Bonus Depreciation in a Nutshell 

Bonus depreciation has been available in varying amounts for some tim e. Immediately prior to the passage of the TCJA, for example, taxpayers generally could claim a depreciation deduction for 50% of the purchase price of qualified property in the first year — as opposed to deducting smaller amounts over the useful life of the property under the modified accelerated cost recovery system (MACRS). 

The TCJA expanded the deduction to 100% in the year qualified property is placed in service through 2022, with the amount dropping each subsequent year by 20%, until bonus depreciation sunsets in 2027, unless Congress acts to extend it. Special rules apply to property with longer recovery periods. 

Businesses can take advantage of the deduction by purchasing, among other things, property with a useful life of 20 years or less. That includes computer systems, software, certain vehicles, machinery, equipment and office furniture. 

Both new and used property can qualify. Used property generally qualifies if it wasn’t: 

  • Used by the taxpayer or a predecessor before acquiring it, 
  • Acquired from a related party, and 
  • Acquired as part of a tax-free transaction. 

Qualified improvement property (generally, interior improvements to nonresidential property, excluding elevators, escalators, interior structural framework and building expansion) also qualify for bonus depreciation. A drafting error in the TCJA indicated otherwise, but the CARES Act, enacted in 2020, retroactively made such property eligible for bonus depreciation. Taxpayers that placed qualified improvement property in service in 2018, 2019 or 2020 may, generally, now claim any related deductions not claimed then — subject to certain restrictions. 

Buildings themselves aren’t eligible for bonus depreciation, with their useful life of 27.5 (residential) or 39 (commercial) years — but cost segregation studies can help businesses identify components that might be. These studies identify parts of real property that are actually tangible personal property. Such property has shorter depreciation recovery periods and therefore qualifies for bonus depreciation in the year placed in service. 

The placed-in-service requirement is particularly critical for those wishing to claim 100% bonus depreciation before the maximum deduction amount falls to 80% in 2023. With the continuing shipping delays and shortages in labor, materials and supplies, taxpayers should place their orders promptly to increase the odds of being able to deploy qualifying property in their businesses before year-end. 

Note, too, that bonus depreciation is automatically applied by the IRS unless a taxpayer opts out. Elections apply to all qualified property in the same class of property that is placed in service in the same tax year (for example, all five-year MACRS property). 

Bonus Depreciation vs. Section 179 Expensing 

Taxpayers sometimes confuse bonus depreciation with Sec. 179 expensing. The two tax breaks are similar, but distinct. 

Like bonus deprecation, Sec. 179 allows a taxpayer to deduct 100% of the purchase price of new and used eligible assets. Eligible assets include software, computer and office equipment, certain vehicles and machinery, as well as qualified improvement property. 

But Sec. 179 is subject to some limits that don’t apply to bonus depreciation. For example, the maximum allowable deduction for 2022 is $1.08 million. 

In addition, the deduction is intended to benefit small- and medium-sized businesses so it begins phasing out on a dollar-for-dollar basis when qualifying property purchases exceed $2.7 million. In other words, the deduction isn’t available if the cost of Sec. 179 property placed in service this year is $3.78 million or more. 

The Sec. 179 deduction also is limited by the amount of a business’s taxable income; applying the deduction can’t create a loss for the business. Any cost not deductible in the first year can be carried over to the next year for an unlimited number of years. Such carried-over costs must be deducted according to age — for example, costs carried over from 2019 must be deducted before those carried over from 2020. 

Alternatively, the business can claim the excess as bonus depreciation in the first year. For example, say you purchase machinery that costs $20,000 but, exclusive of that amount, have only $15,000 in income for the year it’s placed in service. Presuming you’re otherwise eligible, you can deduct $15,000 under Sec. 179 and the remaining $5,000 as bonus depreciation. 

Also in contrast to bonus depreciation, the Sec. 179 deduction isn’t automatic. You must claim it on a property-by-property basis. 

Some Caveats 

At first glance, bonus depreciation can seem like a no-brainer. However, it’s not necessarily advisable in every situation. 

For example, taxpayers who claim the qualified business income (QBI) deduction for pass-through businesses could find that bonus depreciation backfires. The amount of your QBI deduction is limited by your taxable income, and bonus depreciation will reduce this income. Like bonus depreciation, the QBI deduction is scheduled to expire in 2026, so you might want to maximize it before then. 

The QBI deduction isn’t the only tax break that depends on taxable income. Increasing your depreciation deduction also could affect the value of expiring net operating losses and charitable contribution and credit carryforwards. 

And deduction acceleration strategies always should take into account tax bracket expectations going forward. The value of any deduction is higher when you’re subject to higher tax rates. Newer businesses that currently have relatively low incomes might prefer to spread out depreciation, for example. With bonus depreciation, though, you’ll also need to account for the coming declines in the maximum deduction amounts. 

Buy Now, Decide Later 

If you plan on purchasing bonus depreciation qualifying property, it may be wise to do so and place it in service before year end to maximize your options. We can help you chart the most advantageous course of action based on your specific circumstances and the upcoming changes in tax law.

Holly Pett, CPA, EA
D 262.404.2109
PODCAST
Step-Up in Basis at Death

The step up in basis at death rule says that when someone dies, most of their assets receive a new tax basis and holding period. The new tax basis is the fair market value as of the date of death, regardless of the original purchase price.

This podcast covers what you need to know about the step up in basis at death and how these provisions impact far more people than just the rich.
Important Considerations When Engaging in a Like-Kind Exchange
Are you considering selling real property held for investment or used in your trade or business? You may be able to dispose of appreciated real property without being taxed on the gain by exchanging it through a “like-kind” or Section 1031 exchange rather than selling it outright. 

A like-kind exchange is a swap of real property held for investment or for productive use in your trade or business for like-kind investment real property or business real property. For these purposes, “like-kind” is very broadly defined, and most real property is considered to be like-kind with other real property. However, neither the relinquished property nor the replacement property can be real property held primarily for sale. If you’re unsure whether your property is eligible for a like-kind exchange, contact us to discuss the matter. 

Here’s How the Tax Rules Work 

If it’s a straight asset-for-asset exchange, you won’t have to recognize any gain from the exchange. You’ll take the same “basis” (your cost for tax purposes) in the replacement property that you had in the relinquished property. Even if you don’t have to recognize any gain on the exchange, you still have to report the transaction on a form that is attached to your tax return. 

However, the properties usually aren’t equal in value, so some cash or other (non-like-kind) property is thrown into the deal. This cash or other property is known as “boot.” Keep in mind that amounts typically part of real estate transactions such as property tax pro-rations or tenant security deposits are treated as cash boot received or paid, depending what side of the transaction they are on. If boot is involved, you may have to recognize a gain, but only up to the net amount of boot you receive in the exchange. In these situations, the basis you get in the like-kind replacement property you receive is equal to the basis you had in the relinquished property you gave up reduced by the amount of boot you received but increased by the amount of any gain recognized. 

Here’s an Example 

Let’s say you exchange land (investment property) with a basis of $100,000 for a building (investment property) valued at $120,000 plus $15,000 in cash. Your realized gain on the exchange is $35,000: You received $135,000 in value for an asset with a basis of $100,000. However, since it’s a like-kind exchange, you only have to recognize $15,000 of your gain: the amount of cash (boot) you received. Your basis in the new building (the replacement property) will be $100,000, which is your original basis in the relinquished property you gave up ($100,000) plus the $15,000 gain recognized, minus the $15,000 boot received.

No matter how much boot is received, you’ll never recognize more than your actual (“realized”) gain on the exchange.

If the property you’re exchanging is subject to debt from which you’re being relieved, the amount of the debt is treated as boot. The theory is that if someone takes over your debt, it’s equivalent to them giving you cash. If the replacement property is also subject to debt, then you’re only treated as receiving boot to the extent of your “net debt relief” (the amount by which the debt you become free of exceeds the debt you pick up).

Like-kind exchanges can be complex but they can be a good tax-deferred way to dispose of investment or trade or business assets. Give us a call to answer any additional questions you have or assist with the transaction.

Chris Felton, CPA
D 262.404.2114
A Tax Break for Educators Gets an Update
Teachers who are setting up their classrooms for a new school year often pay for some of their classroom supplies out-of-pocket. They can recoup some of that cost by taking advantage of a special tax break for educators. This deduction gained new importance after the 2017 passage of the Tax Cuts and Jobs Act (TCJA). For 2022, the deduction amount has been bumped up and the list of qualifying expenses has expanded.  

The Old-School Way

Before 2018, employees who had unreimbursed out-of-pocket expenses could potentially deduct them if they were ordinary and necessary to the “business” of being an employee. A teacher’s out-of-pocket classroom expenses could qualify. Those expenses were claimed as a miscellaneous deduction, subject to a 2% of adjusted gross income (AGI) floor. That meant that only taxpayers who itemized deductions could enjoy a tax benefit, and then only to the extent that their deductions exceeded the 2% floor.

For 2018 through 2025, the TCJA has suspended miscellaneous itemized deductions subject to the 2% of AGI floor. Fortunately, qualifying educators can still deduct some unreimbursed out-of-pocket classroom costs using the educator expense deduction.

The New-School Way

Back in 2002, Congress created the above-the-line educator expense deduction. An above-the-line deduction is one that’s subtracted from your gross income to determine your AGI. It can be claimed even by taxpayers who don’t itemize deductions. This is especially significant because as part of the TCJA, the standard deduction has nearly doubled, and that means that fewer taxpayers now itemize deductions.

For 2022, qualifying elementary and secondary school teachers and other eligible educators (such as counselors and principals) can deduct up to $300 of qualified expenses. Two married educators who file a joint tax return can deduct up to $600 of unreimbursed expenses — limited to $300 each.

Qualified expenses include amounts paid or incurred during the tax year for books, supplies, computer equipment, related software, services, and other equipment and materials used in classrooms. The cost of certain professional development courses may be deductible. Also, protective items to prevent the spread of COVID-19 such as hand sanitizers, disinfectants and other items recommended by the Centers for Disease Control for this purpose are also deductible. However, homeschooling supplies and nonathletic supplies for health or physical education courses aren’t deductible. 

More Details

Some additional rules apply to the educator expense deduction. If you’re an educator or you know one who might be interested in this tax break, please contact us for more details.

 

Steve Arnold, CPA, EA, Certified QuickBooks Online Proadvisor
D 262.243.9
Tax Tip Tuesday - Video Short
What Is an HSA and How Does It Work

This week, Dave gives 8 basic facts you need to know about Health Savings Accounts (HSA).
Medicare Premiums May Lower Your Taxes
Do you pay premiums for Medicare health insurance? If so, you may be able to combine them with other qualifying health care expenses and claim them as an itemized deduction for medical expenses on your individual tax return. This includes amounts for “Medigap” insurance and Medicare Advantage plans, which cover some costs that Medicare Parts A and B don’t cover.

For 2022, you can deduct medical expenses only if you itemize deductions and only to the extent that total qualifying expenses exceeded 7.5% of your adjusted gross income. The Tax Cuts and Jobs Act nearly doubled the standard deduction amounts for 2018 through 2025. For tax year 2022, the standard deduction amounts are: $12,950 for single filers; $25,900 for married joint-filing couples; and $19,400 for heads of households. Higher standard deductions mean that fewer individuals are itemizing deductions. However, if you have significant medical expenses, including Medicare premiums, you may be able to itemize and enjoy some tax savings.

Important note: Self-employed people and shareholder-employees of S corporations can generally claim an above-the-line deduction for their health insurance premiums, including Medicare premiums. That means they don’t need to itemize to get the tax savings from their premiums.

In addition to Medicare premiums, you can deduct a variety of other medical expenses, including those for ambulance services, dental treatment, dentures, eyeglasses, hospital services, lab tests, qualified long-term care services and prescription medicines. You may also qualify to deduct transportation costs to get to medical appointments. If you drive, track your mileage and you can deduct 18 cents per mile for 2022.

Contact us with your questions about Medicare coverage options or claiming medical expense deductions on your personal tax return. We can help you identify an optimal overall tax-planning strategy based on your personal circumstances.

Charlie Wendlandt, CPA
D 715.384.1989
More Resources from CPA-HQ
Using Alternative Energy for Business Can Bring Tax Benefits

A valuable federal income tax benefit — in the form of a business energy credit — applies to the acquisition of many types of alternative energy property. The credit is intended primarily for business users of alternative energy. This article provides details.
Selling Your Business? An Installment Sale May Yield Tax Benefits

Individuals who plan to transfer real estate, a family business or other assets that are expected to appreciate dramatically in the future may want to consider an installment sale. This option may provide benefits, including the ability to freeze asset values for estate tax purposes and remove future appreciation from the owner’s taxable estate.
How Do Taxes Factor Into an M&A Transaction?

Buying or selling a business may be the most critical transaction you ever make. If your business is considering merging with or acquiring another business, it’s important to understand how the transaction will be taxed under current law. Here are some considerations.