Mastering the Maze of Bonus Depreciation and Deductions with Richard

Welcome to the Profitable Painter Podcast. The mission of this podcast is simple: to help you navigate the financial and tax aspects of starting, running, and scaling a professional painting business. From the brushes and ladders to the spreadsheets and balance sheets, we've got you covered. But before we dive in, a quick word of caution: while we strive to provide accurate and up-to-date financial and tax information, nothing you hear on this podcast should be considered as financial advice specifically for you or your business. We're here to share general knowledge and experiences, not to replace the tailored advice you get from a professional financial advisor or tax consultant. We strongly recommend you seeking individualized advice before making any significant financial decisions.

This is Daniel, the founder of Bookkeeping for Painters, and this is Richard, tax director with Bookkeeping for Painters.

How you doing today, Richard?

I'm doing pretty good. I'm getting ready for the weekend. It's a beautiful Friday afternoon. Uh, we're kind of— I don't know, we're kind of like the downhill side of summer here in the Upper Midwest, so it's still warm but it's not quite as hot. Yeah, it's nice, but I have to mow my lawn more often now.

Yeah, it's crazy how fast the summer went, went by. It's, it's insane. But, uh, yeah, so today we are talking about bonus depreciation. Super exciting. You know, it's not often that the IRS uses terms like bonus, so it makes me feel excited, you know?

So it's like you won something on a game show.

Yeah.

Here's— you pay your taxes and you get yourself a bonus.

Yeah. So, but we'll dig into this topic and it's probably not as cool sounding as— I mean, it's cool, it can be cool, but it's not cool. It's not good for everybody to take it. But we'll dig into that and, you know, go through when it might make sense to do bonus depreciation, do bonus depreciation, when it might not, and some things to consider. So first of all, we probably should just talk about what is depreciation and when, when do we, use it.

Yeah, yeah, depreciation is kind of a misunderstood thing sometimes. Uh, so kind of, kind of put it in a nutshell, you have two types of, of business expenses. You have your, your normal everyday expenses that you pay for and you write off as a deduction in the same year that you purchased it. So for example, you go out and you buy copier paper and copier toner that's going to get used up within the year. You write that off in the year you, you buy it. But let's say you go and you buy yourself a brand new copier and you spend, you know, $10,000 on this piece of equipment that's going to last for 7 years. Well, the IRS doesn't want you to just write off $10,000 in the year that you purchased it because this is something that has a lifespan of more than 1 year. They want you to stretch it out. So in this case, you would depreciate this over the recovery period, which in, in the case of a copier would be 7 years. And, you know, different assets have different recovery periods. Some can be short as, you know, 3 years, uh, some can be as long as 15 or 20, or, or if it's real estate, it could be even, you know, 39 years. Um, but that's, that's the big difference between like a normal expense and a capital asset that has to be depreciated.

Okay. So basically when you buy one of these assets, you, you can't just take the full deduction in the, in the year you buy it. Generally speaking, you have to take a portion of the deduction over the useful life of that asset.

Right, that's the concept behind it. Yeah. Now, um, to know if something is going to be depreciated or not, there's, there's pretty much like, like 4 questions. And if you answer yes to all these questions, then it's probably something that's going to be depreciated. And the first thing is, is do you own the property? So you can't depreciate something that you don't actually own. So if you're renting a car, that's different than if you own a car. If you're renting a copier, lease payments would be immediately expensed, whereas purchasing a copier, they would be depreciated. The second question is, is the property being used in a business to produce income? So only business property gets depreciated Your personal property, your personal vehicle or jet ski or camper, those do not get depreciated unless you're using that to generate income in an actual business. If you're using it for hobby income, then there's no deduction. The third question is, does the property have a determinable useful life? Most things that you buy are going to have a determinable useful life. You know, we can kind of put a number on how long a copier lasts or how long a tool is going to last. Things that are kind of like intangible, things like patents, non-compete agreements, those, those are handled with amateurization and are kind of outside the scope of what we're talking about. And then is that useful life more than 1 year? If it's more than 1 year, it gets depreciated. If it's going to be used up and consumed within 1 year, we just write it off as an expense in that year. And just kind of a little side note on that, you know, we can probably imagine some situations where we have very inexpensive assets that are going to last more than 1 year. You know, maybe we buy a $400 laptop or, you know, a $1,000 cell phone. Seems like kind of a nuisance. Yes, yes. Although, although if you use a screwdriver like I do, you might not get a full year out of it. You're probably better with your tools than I am. Yeah. Um, but yeah, right, you don't want to have to depreciate a screwdriver. So the IRS does have a safe harbor it's $2,500. If you purchase something $2,500 or less and you want to write that off fully in the year you buy it, you go ahead and do that, even if it does have, um, you know, more than, than one year's worth of life.

So basically we're, we're talking about like paint sprayers. If, if the paint sprayer is like over $2,500, which some of them are, if it's over $2,500, you got to depreciate it instead of taking the full deduction in the year that you buy it, generally speaking. But there are are some exceptions we'll talk about. And then, and then the other assets that you might have in your painting business would be vehicles. Obviously, there's an asset that lasts several years, so that might be another type of asset that you have, or maybe a generator. Um, so those, those kind of larger big tools or equipment, and then, and vehicles, I think would, would apply to a lot of painting business owners out there. Those are the kind of, kinds of things that would have a depreciation applied to them.

Yeah, those are typically the things we see, especially vehicles, paint sprayers. I might throw in— sometimes we'll see, you know, very expensive scaffolding or ladders depending on, you know, how elaborate that is. That might be in there. But yeah, that's typical for our clients. So yeah, so the concept is we stretch it out, but then we have, right, this is the tax code, so there's always the exception to the rule. We have things that can accelerate depreciation, namely Section 179 of the tax code. And more recently, we have what's called bonus depreciation. And these are provisions that allow us to either fully expense these capital assets in the year that they're purchased or expense a portion of them more than we normally would be able to. So Section 179 has been around for quite a while, but bonus depreciation is new since 2018. Bonus depreciation kind of expands on what Section 179 does does it a little bit better, uh, but it's also a temporary provision. So from 2018 to 2022, uh, being last year, bonus depreciation was available for 100%. You buy a $10,000 paint sprayer, you write off the full $10,000. Now that we're in 2023, we're starting to see bonus depreciation phase down. Uh, 2023, we are down to 80%. So now with that paint sprayer, we're only writing off $8,000. Next year it will be 60%. 2025, 40%. 2026, 20%. And then it's designed to phase out completely in 2027. Um, will that actually happen? We're gonna have to wait to see what Congress decides. There's a lot of provisions in the Tax Cuts and Jobs Act that we don't know what's going to be around, um, you know, in the next few years. So, so if you're listening to this, you know, 5 years from now, uh, you know, there may be some changes. But as of now, those are the phase-outs. Now bonus depreciation is kind of interesting because whereas with Section 179 you opt in, in other words, you say I choose to take this piece of equipment and accelerate depreciation. Bonus depreciation, you opt out of. Bonus depreciation is the default mode, so the IRS is assuming that you're going to use this on all of your assets unless you tell them you don't want to. The other thing is that it has to whatever you do for, um, one asset in a recovery, uh, period, you have to do for all those assets. Now, what I mean by that is, let's say you have 5 pieces of equipment that is, uh, 7-year recovery equipment. If you— by default, all 5 pieces are going to be bonus depreciated. If you opt out, then none of them will be bonus depreciated. But what you can't do is pick one or two and not the others. If you want to do that, it is available through Section 179, but that is a big difference between bonus and Section 179.

So when you say— I'm kind of confused because why would you ever want to opt out of something where someone's trying to give you a bonus? The IRS is saying, hey, here's some bonus depreciation, and I'm going to say no, no thank you, I'm good, I'm going to go ahead and pay taxes and stuff. Why would I— why would someone want to do that?

That, that's a good question. So with, with what I'm calling accelerated depreciation, whether it's bonus or 179, keep in mind that this is not a gift from the IRS. This is your tax deduction that they are allowing you to take earlier than you normally would. Now, a lot of times that makes sense because keeping our money, we can put that money to work for us, we can do good things with it. But there may be some situations where you don't want to use up your tax deduction all in the first year. So for example, let's say you have not a great year. And you don't have a lot of income. Well, lower income means lower tax bracket. If I use up all my tax deduction now, what happens in the future when I have more income and am in a higher tax bracket? If I have $10,000 of deductions available to me, I would rather use that when my tax bracket is 35% than use it when my tax bracket is 12%. And so it might make sense to stretch that out so that you are saving deductions for future years if they're going to be more valuable to you in future years. Another thing we want to think about that this gets overlooked a lot, so I really, I really want to draw attention to this, is that when we sell the asset, um, a lot of times we don't use things up completely. Let's say we buy a pickup truck. If we drive the wheels off of it and it goes to the junkyard, then we don't have anything to worry about because we fully depreciated it. It has no residual value. But what happens if we drive it for a few years and then we sell it? And say we get, I don't know, $20,000 for our truck. If we've already depreciated it, then we have to pay back that tax break when we go to sell it. So if it's fully depreciated and we sell it for $20,000, now we're paying taxes on $20,000, and we might be in that higher tax bracket when we do it. This also applies if we trade that truck in. Didn't— now, it didn't always be this way. This is a recent change. But if you trade your vehicle in to get a new one, whatever the dealer gives you for that vehicle would be the sale price of that vehicle. And so we got to take that into consideration. If we fully depreciated it and the dealer gives us $20,000 for it, we're going to be on the hook for some extra taxes.

Yeah, this came up a couple of years ago. I think I had a client come to us. He had previously taken Section 179, which is on one of his vehicles, his larger vehicles. And so he got to expense the full amount in the previous year. But then it was like a year or two later, he was trying to trade that same vehicle in. For a new— to upgrade, get a new vehicle for the newest model. And we're like, hey, you took the Section 179, you know, a couple of years ago on this. So now you're going to have to pay that depreciation, accelerated depreciation you took back to the IRS. So you can't like take 179, Section 179, you know, one year and then two years later trade it in and do a Section 179 again. You can't like keep just taking Section 179. A lot of folks don't realize that they could— oh, I can just fully expense it as long as it meets the Section 179 requirements, then I can just keep doing that and just trading my vehicles in and getting a big deduction.

Exactly. We— it's very easy to see the big tax breaks up front, but we need to stop and think about what happens when we go to dispose. Of the property. And dispose means, uh, sell, trade in, or convert to personal use. So we can't take the pickup truck that we were using for work and then give it to ourselves a few years later and not expect to recapture that depreciation. So definitely a conversation to have with your tax preparer and try to understand like the long-term effects. It may very well be in your interest to get your tax break upfront, especially if you're going to completely use up that vehicle. But if you intend to trade it in right away, or you intend to maybe, you know, convert that to personal use within a year or two, be aware of the consequences of accelerating depreciation.

Yeah. Another common thing I see folks come to us and they're, you know, a lot of folks know about the Section 179 now and bonus depreciation. So they might kind of know like, oh yeah, that's something I want to make sure I take for my vehicle. Or maybe they had just taken it on a previous year. And so, but looking at their situation, it didn't really make sense based off of the cost of their vehicle and the amount of mileage they're putting it off, putting on their vehicle. Could you talk like a little bit about when, when, when would be a time where you might not want to do the bonus depreciation, bonus depreciation or Section 179 on a vehicle that has high mileage and maybe isn't that expensive?

Sure. Sure. So when it comes to vehicles especially, there's, there's a lot of nuance and complexity here. Uh, it's how you expense it's going to depend a lot on, you know, do you own the vehicle, does your business own the vehicle, is it used 100% for business, is there a mix between personal and business? Um, but If you are able to use the standard mileage deduction, so the IRS is— if you don't want to figure out actual expenses, so actual depreciation, actual fuel, actual maintenance, you can use a cents-per-mile formula to figure out what your deduction should be. That formula is adjusted each year. This year it is 65.5 cents per mile. So you would log your mileage, and I cannot emphasize the importance of keeping an accurate mileage log for deductions. Log your mileage, multiply that by 65.5 cents, that's your deduction. In some cases, if you have an inexpensive vehicle or a very fuel-efficient vehicle, or a vehicle that is— does not cost you a lot to operate, you may find yourself much better off taking 65.5 cents per mile versus using actual expenses and depreciation. Conversely, let's say you're a doctor who likes to drive a $150,000 Porsche and you only drive it to the clinic that's a few miles away once a week. You're not gonna have a lot of mileage there, and you're gonna have a lot of depreciation. In that extreme situation, actual expenses are gonna be a lot more advantageous to this doctor. But most of us are not in that situation. So again, talk to your tax professional. Does it make more sense to take actual expenses Or do I have a very efficient, low cost of— or low operating cost vehicle? And it might be more beneficial to do the cents per mile.

Yeah. And I just wanted to highlight one of the couple of things you said. The IRS has a couple of topics that are kind of hot topics with them, and vehicles is definitely one of them. So making sure your documentation is dialed in for vehicles, especially when it comes to mileage, like you said. So if you're doing the mileage, you know, it might make sense to do mileage. Just make sure you're tracking that. There are some apps out there that can help you track it a little bit easier. MileIQ is one where it remembers, like, if you're going, um, it kind of remembers your routes to and classifies it as business or personal based off of your driving habits and stuff. So, and then it will give you a compliant mileage log at the end of the year that you can have, you know, for your records. And so it makes it a little bit easier. Obviously, you can also just have a book, you know, on your dash and then just write your mileage and track business and personal, which is kind of a little arduous, but that will definitely meet the requirement. Um, but MileIQ I think is pretty relatively cheap.

Yeah, you want date, you want miles, preferably starting odometer and ending odometer, and then a brief business purpose, uh, meet with client, uh, quality control check, whatever. It doesn't have to be super detailed. Don't just write business next to everything. Those logs have been disallowed under examination. And then another thing, it needs to be contemporaneous, so it needs to be filled out, you know, when the driving happens. If we wait to the end of the year and we try and like reconstruct it from memory, those logs usually get disallowed under examination. So this is kind of a, you know, cover your butt type thing. And I know it's, you know, a pain in the neck, and we don't really want to have to add more paperwork to our, to our day, uh, but because the mileage deduction or vehicle deductions in general are so valuable, uh, it is, it is worth doing the extra record keeping.

Yeah, and yeah, and I think it's, it's a good case to, to use some, some sort of app, and you can kind of automate your, your notes because you're usually doing the same handful of tasks, you know, going to do an estimate, did an estimate, you know, going to the paint store, you know, those things you shouldn't have to type out on your phone a thousand times. You just select it from a dropdown and move on.

Yeah, yeah, we, we talked about vehicles a lot. I just wanted to touch on real estate real quick because I've been getting this question often. Can we use bonus depreciation on real estate? So, so the short answer is not on real estate itself. Real estate being, you know, land, land which is never depreciable, buildings, that sort of thing. That has— there's special rules for that. Residential is 27.5 years, commercial is 39. But we might be able to use bonus depreciation on the things inside the building. Things that are not components of the building. So furniture, fixtures, things like that. Uh, I heard a, um, a tax professional, she gave a neat illustration. She said that when she was a young girl, she had one of those Barbie Dream Homes, you know, with the plastic set and with all the little, you know, things inside. She said if I took the roof off my Barbie Dream Home, I turned it upside down and I shook it, Whatever falls out, I can probably bonus depreciate. Whatever stays in is going to be a component of the real estate. So take that with a grain of salt, but I thought that was pretty smart. So yeah, if you're buying real estate and you want to try to, you know, increase some of your expenses, look for things that would, you know, fall out under a shake test, generally speaking. Oh, so some other aspects of bonus depreciation. So Section 179 required that the asset be brand new. Bonus depreciation just requires that the asset be new to you. So if you purchase a used vehicle or used equipment, bonus depreciation can apply, uh, but it does have to be acquired by purchase. So, you know, can't be gifted to you. You can't inherit it from Uncle Fred. Uh, does need to be something that, that you pay for with, with money. Um, you can combine bonus and Section 179. Section 179 is limited to about $1.2 million per taxpayer per year. Bonus does not have a limit. So You know, these, these tax strategies can certainly be valuable if used properly. Kind of jumping back to vehicles, I did want to mention that there is a limit on how much you can depreciate certain vehicles in the first year. So if you have a vehicle that can be used for both personal and business use, like a sedan, or, or, you know, a typical car, and that vehicle is less than 6,000 pounds, you are limited to $20,200 maximum depreciation in the first year. That's bonus and Section 179. That's the max. However, if you have an SUV that weighs more than 6,000 pounds, then there is no limit. Uh, Tesla was using this as a selling point for their Model X. Because the Model X was technically over 6,000 pounds. People were buying these, putting them into their businesses, uh, and being able to fully depreciate them in the first year. If you have a vehicle that is not practical for passenger use— so let's say a work van that only has the two seats up front and the rest is built out for cargo, uh, even if that's under 6,000 pounds, you can go ahead and fully depreciate that. Because that is business only. There is no practical, uh, personal use there. So a lot, a lot of different rules, a lot of different nuance. We're not going to cover everything today. Oh, I want to throw those out there.

Well, one thing we need to cover is, uh, in light of recent news, what about an alien craft with non-human biologics in it? What would that go for?

Well, um, does the taxpayer own the property? Uh, does— is it used for— is it used for, uh, uh, in business to produce income?

Yeah, I mean, if it's crashed and they found it, you know, and it's— I guess it's theirs now.

Yeah, so yeah, it needs to be acquired by purchase, so we might— we might have to buy that from the aliens and then, you know, sell rides in it or something like that.

Uh, okay, good. Yeah, good stuff.

Okay. Yeah, if you, if you get one, Daniel, let me know because I'm, I'm curious how, how those things handle. All right, they probably weigh more than 6,000 pounds, so I don't know.

They move, move like they, uh, they're just, you know, weigh nothing, so who knows.

All right, that's true. Gotta let the tax laws catch up with reality, right?

Yeah, exactly.

Find that arbitrage there.

All right, cool. So I think we, we, uh, cover this topic. Are there any key takeaways we want to, um, kind of hammer home with depreciation, um, for the listeners?

Yes, my recommendation is think carefully about your depreciation and talk about it with your tax pro. Simply taking as much accelerated depreciation as possible may not be in your best interest. I'm also going to recommend that you have this conversation well before the end of the year because you may choose to make some purchases before December 31st, um, based on income tax liability, uh, you know, the fact that Bonus depreciation is getting reduced by 20% each year. So there's a lot of tax planning opportunities here, but we need to be proactive and we need to have, um, you know, intentional planning to make sure that we're getting the most out of them.

Okay, awesome. All right, if you have any questions about depreciation, what can you depreciate, What can you not depreciate? Or whatever your questions may be, go to Facebook, type in Grow Your Painting Business, and join the private group. And you can ask any questions you'd like or make recommendations for future podcast episodes. Join in the conversation. We'd love to hear from you.

Yeah, absolutely. Um, let us know your thoughts. And, uh, thank you for listening. Until next time, um, happy depreciation. Is that a thing? Happy—

have fun depreciating.

Yeah. Yeah.