Write-Offs That Work: Depreciation Tactics Contractors Can’t Afford to Miss
Depreciation is one of the most effective tax planning tools available to contractors. However, the rules for tax depreciation differ from those used for financial reporting, and understanding these differences is key to maximizing your deductions.
Book vs. Tax Depreciation: What’s the Difference?
Book depreciation is used for financial statements and follows Generally Accepted Accounting Principles (GAAP). It typically uses the straight-line method, spreading the cost of an asset evenly over its estimated useful life, as determined by management based on factors like expected usage, manufacturer guidelines, and industry norms. The goal is to match expenses with the actual use of the asset.
Tax depreciation, on the other hand, is governed by IRS rules. The IRS prescribes specific methods and recovery periods, often allowing for faster write-offs than book depreciation. The primary system used is the Modified Accelerated Cost Recovery System (MACRS), which accelerates deductions in the early years of an asset’s life.
Another common difference is that under GAAP, salvage value represents the estimated residual amount an entity expects to recover at the end of an asset’s useful life, and it is deducted from the depreciable base when calculating depreciation expense. In contrast, tax-basis accounting under the Internal Revenue Code generally assumes no salvage value, allowing the full cost of property and equipment to be depreciated for tax purposes. This difference creates temporary book-tax differences that must be reconciled in financial reporting
Key Tax Depreciation Options for Contractors
1. MACRS (Modified Accelerated Cost Recovery System)
MACRS is the standard method for tax depreciation. It assigns assets to specific classes with set recovery periods and methods:
- Accelerated Methods: Most equipment and vehicles use the 200% or 150% declining balance method, which front-loads deductions.
- 200% declining balance depreciates an asset at twice the straight-line rate. For example, if an asset has a 5‑year useful life, the straight-line rate is 20% (100% ÷ 5). The 200% declining balance rate is 40% (20% × 2).
- 150% declining balance depreciates an asset at 1.5 times the straight-line rate.
- Straight-Line Method: Used for buildings (27.5 years for residential rental property, 39 years for commercial property).
Example: A $50,000 excavator (classified as 5‑year property) can generate larger deductions in the early years under MACRS than under straight-line depreciation.
2. Section 179 Expensing
Section 179 allows contractors to immediately expense the cost of qualifying property, up to $2,500,000 in 2025, with a phase-out beginning at $4,000,000 in total purchases. This deduction is limited to taxable business income and is applied before bonus depreciation.
Qualifying property: Most tangible personal property, including machinery, equipment, and certain vehicles.
Vehicles qualify for Section 179 but are subject to specific limits based on the weight and type of vehicle:
- SUVs and Heavy Vehicles: Certain SUVs (GVWR over 6,000 lbs but not more than 14,000 lbs) have a maximum Section 179 deduction of $31,300 for 2025.
- Passenger Automobiles: Includes small cars and SUVs or trucks under 6,000 lbs. Maximum first-year depreciation is $12,200 for 2025.
- Exceptions for Vehicles Over 6,000 lbs: The $31,300 limit does not apply if the vehicle meets one of the following:
- Large passenger vans or buses (seating more than nine behind the driver).
- Pickup trucks with a cargo bed at least six feet long (measured from the inside of the closed tailgate to the inside of the bulkhead) and not readily accessible from the passenger compartment.
- Vehicles with no seating behind the driver and no body section extending more than 30 inches beyond the windshield (e.g., certain box trucks and delivery vans).
3. Bonus Depreciation
Bonus depreciation allows an immediate deduction of a percentage of the cost of eligible property. For 2025:
- 40% bonus depreciation for property placed in service before January 20, 2025.
- 100% bonus depreciation for property acquired after January 19, 2025 (made permanent under OBBBA).
- No annual cap or income limitation.
- Applies to both new and used property (if new to the taxpayer).
Vehicles are eligible for bonus depreciation, but they have specific limits based on weight, similar to Section 179:
- Heavy SUVs (over 6,000 lbs GVWR): Not subject to passenger automobile limits, so 100% bonus depreciation may apply if business-use requirements are met.
- Passenger Automobiles: Includes small cars and SUVs or trucks under 6,000 lbs. Maximum first-year depreciation is $20,200.
4. Alternative Depreciation System (ADS)
Certain property must use ADS, which requires straight-line depreciation over longer periods. This applies to specific assets, including property used predominantly outside the U.S. or when the taxpayer elects ADS.
Special Considerations for Contractors
- Qualified Improvement Property (QIP): Interior improvements to nonresidential buildings may qualify for 15-year depreciation and bonus depreciation unless ADS is required.
- Qualified Production Property (QPP): Some real estate investments may qualify for 100% bonus depreciation if used in a Qualified Production Activity (QPA). Strict timing and use requirements apply. This was part of the One Big Beautiful Bill Act (OBBBA) of 2025 and is meant to encourage domestic manufacturing and production.
- Repairs vs. Capital Improvements: Repairs that do not add significant value or extend the asset’s life may be expensed immediately. Capital improvements must be depreciated.
- De Minimis Safe Harbor: Items costing $2,500 or less ($5,000 with audited financials) may be expensed if a written policy is in place.
- Materials and Supplies: Items costing $200 or less, or with a useful life of 12 months or less, are generally expensed when used.
Depreciation Recapture
Because tax depreciation is typically accelerated, your tax basis is often much lower than your book basis. When an asset is sold, this difference can result in a higher taxable gain than what appears on financial statements. Additionally, depreciation claimed for tax purposes is subject to recapture, meaning the gain up to the amount of depreciation taken is taxed at ordinary income rates, not lower capital gains rates. Depreciation recapture applies to all depreciation taken on personal property and land improvements and applies to any depreciation in excess of straight-line for real property.
Example:
You buy equipment for $100,000. After three years, you’ve taken $71,200 in tax depreciation but only $30,000 in book depreciation. You sell the equipment for $70,000.
- Book value = $70,000 → $0 book gain
- Tax basis = $28,800 → $41,200 taxable gain (all ordinary income due to recapture)
Planning Tips for Contractors
- Timing Matters: The year an asset is placed in service determines the available bonus depreciation rate.
- Cost Segregation: A study can identify building components eligible for shorter recovery periods and bonus depreciation.
- State Tax Differences: Some states do not conform to federal bonus depreciation or Section 179 rules.
- Buy vs. Lease: Depending on your situation, either buying or leasing may offer better financial benefits.
- Debt Restructuring: Refinancing or renegotiating loan terms may improve cash flow and lower interest expense.
Conclusion
Contractors have several powerful ways to accelerate depreciation and reduce their tax bills, but the right strategy depends on the asset, timing, and overall tax situation. With recent changes to bonus depreciation and other rules, careful planning is essential. We also help contractors restructure debt to improve cash flow and strengthen their financial position. Before making any decisions, give us a call—we can guide you toward effective tax and debt‑saving strategies.
Jessica Eddlemon, CPA
Manager
