Section 179 Gains Importance as Bonus Depreciation Phases Out

Over the past several years, Section 179 expense has decreased in popularity due to the enactment of bonus depreciation in the 2017 Tax Cuts and Jobs Act. With bonus depreciation facing a complete phase out by 2026, taxpayers focused in real estate may begin to implement Section 179 expense to continue deducting the full cost of depreciable assets in the year they are placed in service.

What is Section 179 Expense?

Section 179 expense allows the taxpayer (except trusts and estates) an immediate deduction on certain types of depreciable property. For the 2023 tax year, the allowable amount of Section 179 expense per taxpayer is $1,160,000. The deduction amount will decrease dollar for dollar on the total amount of qualifying Section 179 property placed into service that year that exceeds $2,890,000. If the total cost for the tax year exceeds $4,050,000, then the deduction is completely disallowed. For tax years beginning in 2024, the maximum section 179 expense deduction is $1,220,000. This limit is reduced by the amount by which the cost of section 179 property placed in service during the tax year exceeds $3,050,000. Section 179 expense is limited to taxable income and cannot create a loss. The disallowed amount can be carried forward and used in future years.

Why is Section 179 Uncommon in Real Estate?

Most real estate businesses are structured as partnerships. With partnerships being a flow-through entity, tax is paid at the individual level. While Section 179 is determined at the partnership level, the important consideration is whether it is beneficial at the individual level. Real estate partnerships are often composed of a large syndication, making it nearly impossible to know the benefit at the final tier level.

Section 179 expense is commonly used in closely held businesses and C corporations. With a closely held business, it is more likely to know the tax positions of the individual partners and whether the Section 179 deduction is allowable and beneficial for each partner. Although C corporations are an uncommon real estate structure, it is an entity where Section 179 may be beneficial. With a C corporation, tax is paid at the entity level; therefore, shareholder level limitations are not a concern. Instead, the focus will shift to minimizing tax liability while not creating a taxable loss.

It is not uncommon in a real estate business for taxable losses to be generated up until the year of sale. However, Section 179 expense cannot be taken in a loss position, and it cannot be used to create a tax loss as well.

As an example, assume a property is break-even before depreciation deductions, and the taxpayer places $1,000,000 of bonus/179-eligible property in-service in 2024. With bonus depreciation at 60%, the property has at minimum $600,000 of loss for the year, which investors may be able to use against other sources of income at the individual level. However, if Section 179 were instead taken, it would be disallowed and carried forward until the property has cumulative income. Therefore, it may be years before the investors reap any sort of benefit from a Section 179 deduction.

If an entity did, however, use Section 179 expense, it would most likely create an unfavorable outcome at the time of sale. A sale on an asset with Section 179 expense will generate ordinary income recapture instead of the preferential 25% real property recapture. At the highest tax rate, this creates an overall 12% gap in the tax rate, which may be the difference in hundreds of thousands in tax due.

When considering Section 179 expense for real estate assets, close attention should be paid to the partner level limitations and the overall tax result. Weaver is here to assist with analysis and planning related to Section 179. Contact us today.

Authored by Leah Miller.

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