One Big Beautiful Bill’s Tax Changes Will Enhance Cash Flow from Capital Expenditures

Two of the new and important tax changes made by the One Big Beautiful Bill Act (OBBBA) allow the full and immediate expensing of certain business assets placed in service during the taxable year. This occurs under changes made in the tax code to (i) 168(k), which permits 100% expensing –known as bonus depreciation – of certain assets acquired after Jan. 19, and (ii) § 179, which has increased the dollar limits for expensing of “section 179 Property” (179 Property) up to $2.5 million (indexed for inflation). 

This immediate and enhanced expensing can generate increased cash flow from capital purchases. The cash flow benefits will be more for longer-lived assets, largely on account of the longer life for a given outlay, but benefits can still result from shorter-lived assets. Businesses must navigate through a maze of rules under §§ 168(k) and 179, and their interplay with each other, to achieve the optimum results from these expensing rules in a capex program.

Bonus Depreciation
OBBBA has restored bonus depreciation, on a permanent basis, allowing the entire cost of “qualified property” acquired after Jan. 19 (and specified plants, planted or grafted after Jan. 19) to be expensed in the first taxable year in which placed in service. Both new and, in certain cases, used property can qualify for bonus depreciation. Under prior law (from the Tax Cuts and Jobs Act), 100% bonus depreciation had declined to 40% for 2025, would go to 20% in 2026 and then zero thereafter. Generally, “qualified property" includes most MACRS-depreciable tangible property having a recovery period of 20 years or less, along with certain computer software, and other property used for specific purposes. Bonus depreciation applies automatically. But a taxpayer can make an affirmative election to opt out of bonus depreciation for the taxable year in which the property is placed in service. The election must apply to all property in the same class and placed in service during the same taxable year. 

Qualified Production Property
When evaluating expensing under bonus depreciation and § 179, consideration must be given to § 168(n), added to the tax code by the new law. It is a temporary provision allowing 100% expensing of the adjusted tax basis of “qualified production property” (QPP). QPP is restricted to the “portion” of nonresidential real estate used as an integral part of manufacturing, production or refining of certain tangible personal property in the United States. This will include the applicable portion of a permanent structure and goes beyond traditional 39-year depreciation that otherwise would apply to this property. Limitations exist on the type of activities and industries that can use the provision.

Original use of the QPP must begin with the taxpayer. This is an elective position and does not automatically apply. If the property ceases to be used for the required purpose at any time during a 10-year period from the date placed in service, §1245 recapture is required as ordinary income. The new provision applies to newly constructed property that has a construction commencement date after Jan. 19, and before Jan. 1, 2029, and placed in service after July 4 and before Jan. 1, 2031, and also applies to qualifying acquired property. Guidance in the use and for clarifications of the new provision will likely be needed from the IRS.

179 Property
OBBBA increased the elective deduction allowed for the 100% expensing of 179 Property placed in service during the taxable year (after Dec. 31, 2024) up to a newly increased limit of $2.5 million, indexed for inflation (Dollar Limitation) (an increase from prior law of $1.25 million that would have otherwise applied in 2025). The inflation-adjusted Dollar Limitation for 2026 will be $2.56 million.

The Dollar Limitation is subject to reduction under two tests:

• First, the deduction begins to phase out, on a dollar-for-dollar basis but not below zero, for the cost of the 179 Property in excess of $4 million (for 2025) (Phase-Out Reduction), indexed for inflation (an increase from prior law of $3.13 million that would have otherwise applied in 2025). The inflation-adjusted Phase-Out Reduction for 2026 will be $4.09 million).
• Second, and after applying the first limitation, the deductible amount cannot exceed business taxable income from the taxpayer’s trade or business (or businesses if more than one) for the taxable year which involves a special calculation.

Any § 179-elected amount not deductible in a taxable year because of the business taxable income limitation has an unlimited carryforward.

For example, assume that property purchases are $4.2 million for the 2025 taxable year and will qualify for § 179 expensing. Business taxable income is $5 million. If an election is made by the taxpayer for § 179 expensing, a deduction is allowed for up to $2.3 million ($4.2 million of property purchases exceeds the $4 million Phase-Out Reduction by $200,000 and this amount reduces the deduction from $2.5 million to $2.3 million).

There is no reduction in this example based on the business taxable income since it is greater than $2.3 million. Note that if purchases of 179 Property exceed $6.5 million in 2025, no § 179 deduction is available (the excess of $6.5 million in purchases over the $4 million Phase-Out Reduction is $2.5 million). As indexed for inflation, the limitation in 2026 will be $6.65 million.

An election must be made in the tax return for § 179 expensing and the specific 179 Property to which the election applies. To have 179 Property, the property must be acquired by purchase for use in the active conduct of a trade or business and must be one of the following:

• Depreciable tangible personal property
• Other tangible property (excluding buildings and their structural components having certain uses)
• Off-the-shelf computer software
• If elected by the taxpayer, “qualified improvement property” (generally certain improvements to the interior of a building placed in service after the building was first placed in service)
• Roofs, HVAC and fire protection, alarm and security systems, also if placed in service after the building was first placed in service

Considerations in Using §§ 168(k) and 179
Sometimes the same property can qualify for expensing under both §§ 168(k) and 179. In these situations, the question arises whether one expensing method is preferable to the other. There are differences between the two provisions. To achieve maximum benefits, in some cases, one might want to opt out of bonus depreciation and use a longer recovery period but still have allowable § 179 expensing or vice versa. It may be beneficial in other cases to have both provisions applied. 

Each situation is fact-specific, and consideration must be given to a number of factors that will include:

• The statutory regimen for the elections in the use of §§ 168(k) and 179, whether in combination with each other or separately, allows room for maneuvering for the provisions to apply in the most advantageous way. An election is made in the tax return for using § 179, and it can apply to specific property or to a portion of the cost of the same property as selected by the taxpayer. The remaining basis of an asset minus the amount deducted under § 179 is subject to depreciation. Bonus depreciation applies automatically unless a taxpayer affirmatively elects to opt out, and this must be done by class. If a taxpayer opts out of a single class, the longer cost recovery period will be used for that class, but bonus depreciation can still apply to the other non-opted out classes.
• Does the taxpayer expect to have a net operating loss for the current year or is there a carryover of a loss from a prior year? Would it be beneficial to reduce the loss for the current year? If so, either (or both) not making a § 179 expensing election and opting out of bonus depreciation for the year to have a longer recovery period should be considered.
• If a pass-through entity is involved, for example, keep in mind any effect of the excess loss limitation in § 461(l) – made permanent by the new law. Calculations will be necessary to accurately determine the impact of § 461(l).
• Think about using tax credits. Assuming a tax credit is available to a taxpayer – for example, under § 38 (relating to the general business credit) – no amount deducted under § 179 will be eligible for the credit.
• If a building is purchased, constructed or remodeled, a cost segregation study will be needed. This study will identify those building components that constitute tangible personal property and allocate building costs to those items, so they are subject to bonus depreciation and § 179 expensing. Otherwise, they might have to be depreciated as part of the building as a whole over a 39-year period applicable to commercial buildings (27.5 years for residential property).
• Roofs, HVAC and fire protection, alarm and security systems can be expensed under § 179 (if placed in service after the building was first placed in service) but are not subject to bonus depreciation. Does this have an impact on how to use the expensing provisions?
• Only property used in the active conduct of a trade or business is eligible for § 179 expenses. Bonus depreciation is broader, as it applies not only to property used in a trade or business, included in a class (under § 162), but also applies to property held for the production of income under § 212 (investment property). If there is both personal and business use, § 179 expensing will apply only to the percentage of business use, which must have been for more than 50% during the year in which the property was placed in service. If business usage is 50% or less, there is no § 179 deduction. Keep in mind recapture if 179 Property has a business usage of 50% or less or is no longer used in the active conduct of a trade or business.
• Consideration should be given to the deduction of up to 20% of qualified business income under § 199A—made permanent by the new law – applicable to individuals and taxpayers taxed as partnerships and S corporations. Calculations will be needed to determine your overall tax position for the year and any impact of this item.
• Be mindful of the special rules that apply in determining the § 179 deduction at the partner/ LLC member or shareholder levels of pass-through entities. The deduction is first determined at the entity level and then passes through to the pass-through entity owner. The deduction at the entity-owner level must be calculated by including all 179 amounts from all trades or businesses of the owner. 
• What is the impact of state law? Some states do not recognize bonus depreciation.

Other factors may deserve consideration. Planning is necessary to achieve optimum use of these new expensing provisions under OBBBA.

Please contact Gerald Burnett or any member of the Phelps Tax team if you have questions or need advice or guidance.