Machinery Buyers Guide For Bonus Depreciation Tax Savings In 2021

Uncle Sam Wants To Assist Buyers Of New And Used Machinery

Machinery buyers and sellers play pivotal roles in our economy — machinery enables us to produce food, construct infrastructure, build homes and offices, and transport materials more efficiently. Investments in machinery are a cornerstone of our high productivity levels.

Congress recognizes that investments in capital goods (like machinery) and research and development are major drivers of long-term economic growth — hence, these categories receive favorable tax treatment.

Bonus depreciation is a tool designed to encourage buyers of heavy machinery to keep investing in modern, efficient fleets.

What Kinds Of Purchases Qualify For Bonus Depreciation?

According to the current IRS guidelines for bonus depreciation, qualified property is defined as tangible personal property with a recovery period of 20 years or less. Most heavy machinery purchases fall under the current tax law — this includes tractors, harvesters, forklifts, excavators, bulldozers, cranes, aerial work platforms (AWPs), telescopic handlers, and more.

Used machinery purchases also qualify for bonus depreciation, provided the used machinery wasn't previously owned by the buyer. The treatment of used machinery changed when the tax law was updated in 2017 — before then, used machinery purchases didn't qualify.

Bonus depreciation isn't applicable to real estate improvements or land purchases. Additionally, there are specific limitations for automobile purchases.

When the tax law was revised in 2017, Congress adjusted the treatment of farm equipment. The new law reduced the recovery period for machinery and equipment used in agricultural operations from seven to five years (for regular tax depreciation, not bonus depreciation). However, this shorter recovery period doesn't apply to grain bins, cotton ginning assets, fences, or other land improvements.

How Is Bonus Depreciation Calculated?

Depreciation spreads the cost of long-term assets across the asset's useful life. Typically, depreciation follows a "depreciation schedule" that allocates portions of the cost to each time period (for example, 20% in Year 1, 15% in Year 2, etc.).

Businesses following US GAAP accounting usually have two separate depreciation schedules: "book depreciation" and "tax depreciation." Book depreciation is used for financial reporting and is generally a smoother rate (equal amounts each year). Managers and bankers often refer to book depreciation. Tax depreciation, on the other hand, is calculated differently and is used solely for tax purposes. Tax accounting differs from book accounting because tax laws frequently change, and tax laws often permit accelerated depreciation.

In 2021, the calculation is straightforward — 100% of the qualifying asset's value. The calculation can vary when other tax incentives like Section 179 are applied. Typically, tax professionals suggest using the full qualifying Section 179 amount first, then applying bonus depreciation to the remaining balance.

A taxpayer can choose to opt out of the additional first-year depreciation for the taxable year the property is placed in service. If the election is made, it applies to all qualified property within the same class of property placed in service by the taxpayer in the same taxable year.

What Is Bonus Depreciation In 2021?

At present, the bonus depreciation amount is 100% of the asset's value. This percentage changes over time as tax laws evolve. The current rate is set to decrease in the future, but new legislation could maintain the high bonus depreciation rate. Congress typically reviews tax laws annually and modifies them.

The current tax law schedule for bonus depreciation is as follows:

Examples Of Bonus Depreciation For New And Used Machinery Purchases

Example 1: You buy a used Caterpillar 301.8 mini excavator for $25,000. You haven't owned this machine before, and you'll use it for business purposes. The qualifying bonus depreciation that year is the full $25,000. Used equipment qualifies for bonus depreciation as long as you didn't own it previously and it's used for business purposes.

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

Example 3: You buy a used John Deere 100 series lawn tractor for $1,200. You'll use it 90% of the time for your home residence and 10% for work purposes. In this case, the purchase doesn't qualify because it's primarily used for personal purposes.

Example 4: You buy a used Volvo Construction Equipment dozer for $60,000. Your business qualifies for Section 179 and you've used Section 179 to cover the dozer cost. You cannot use bonus depreciation for the dozer since you chose to use Section 179 instead.

Example 5: You buy a used Peterbilt heavy-duty truck for $110,000. That year you also bought an International heavy-duty truck and opted not to apply bonus depreciation to the International truck. Since the two assets are similar and purchased in the same year, you must treat them the same when applying bonus depreciation. As a result, the Peterbilt heavy-duty truck won't qualify for bonus depreciation.

How Does Bonus Depreciation Work With Section 179?

Both Section 179 deduction and bonus depreciation are tools to lower your tax bill — both are IRS rules that determine how you handle machinery purchases for tax purposes, and both change over time as the IRS and Congress update the rules.

So what’s the difference? Section 179 allows taxpayers to deduct the cost of qualifying purchases as an expense rather than capitalizing the asset and depreciating it. This distinction is crucial for tax accounting — long-lived assets that can be used for many years are typically treated differently than items with a short lifespan. For instance, a new $300,000 Case IH tractor might have a useful life of more than 50 years if well-maintained (long-lived asset), whereas the DEF fluid you put in the tractor has a short useful life because it gets consumed quickly (expense).

Under standard IRS rules without bonus depreciation and Section 179, long-lived assets are usually depreciated over time for tax purposes. In the example above, only a portion of the $300,000 upfront purchase cost could be deducted each year (see MACRS depreciation). Section 179 and bonus depreciation are methods to accelerate deductions and get tax benefits faster. Tax deductions received earlier are more valuable than those received later because a dollar now can be reinvested and generate returns or interest over time.

In 2021, bonus depreciation and Section 179 are more similar than they’ve been in the past because the bonus depreciation coverage is 100%. In previous years, when bonus depreciation was limited to 50% of an asset’s cost upfront, there were larger differences for taxpayers.

You can combine Section 179 and bonus depreciation in a single year. Typically, tax professionals recommend using the full qualifying amount for Section 179 first, then applying bonus depreciation to the remaining balance.

Key differences between Section 179 and bonus depreciation include:

• Section 179 is treated as an expense, while bonus depreciation capitalizes the asset and depreciates it.
• Section 179 provides a fixed dollar deduction (limited to $1.05 million in 2021), while bonus depreciation allows a fixed percentage of the cost (no limit).
• Section 179 targets small and medium-sized businesses (it has a limit on total qualifying purchases), while there is no cap on bonus depreciation.
• Section 179 covers costs for improving and upgrading real estate, while bonus depreciation does not.
• Section 179 gives you more flexibility to decide how you treat your machinery for tax purposes (for instance, you can choose to receive only half the benefit in a year, then depreciate the remaining balance over a normal term), while bonus depreciation doesn’t. Bonus depreciation must apply to 100% of an asset’s cost, and all similar purchases in that category must be treated the same (if you use bonus depreciation for one asset, you must use it for all similar assets).

Important Note

We wrote this article to help you better understand bonus depreciation and its application to machinery purchases. We are not tax experts, nor are we licensed to provide tax advice. Always consult a professional tax accountant for matters related to your taxes. We cannot be held accountable or responsible for your tax matters.

Laws change over time, and so do interpretations of the law. Tax professionals stay informed about these changes and will guide you through the legislative landscape.

Resources

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

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