Uniform capitalization (UNICAP) tax inventory rules might reduce the current-year benefit of bonus depreciation.
The recent tax reform, commonly known as the Tax Cuts and Jobs Act (TCJA), expanded bonus depreciation to 100 percent for property placed in service after Sept. 27, 2017, and before Jan. 1, 2023. Bonus depreciation is phased out from 2023 through 2026. In addition to increasing the bonus depreciation percentage from 50 percent to 100 percent, the TCJA also allows taxpayers to claim bonus depreciation for purchases of used property.
UNICAP rules require manufacturers and resellers to capitalize certain costs, such as depreciation expense, to inventory. Many companies already capitalize depreciation to inventory through their standard costing methodology, but UNICAP rules might require taxpayers to capitalize additional tax depreciation to their ending inventory. When bonus depreciation results in substantial differences between financial statement and tax depreciation, a portion of the tax deprecation might need to be capitalized to ending inventory, which could materially defer the benefit of bonus depreciation.
The impact of UNICAP on the current-year bonus depreciation adjustment depends on a number of factors. First, only depreciation related to production and resale activities is includible as a UNICAP cost. For example, assets used by a marketing department generally would not be UNICAP costs. Second, companies can use one of several IRS-prescribed simplified methods to calculate UNICAP or develop a methodology based on a taxpayer’s individual facts and circumstances. Use of a simplified method often will result in more UNICAP costs being capitalized because the simplified production or resale methods do not allow businesses to track individual costs to specific production or resale activities. Third, businesses with a higher number of inventory turns generally will capitalize less depreciation expense to ending inventory for UNICAP purposes because more of those costs relating to inventory are sold in the current year.
In most cases, costs capitalized for UNICAP will be deductible in the next tax year, so the effect is a one-year delay to the deduction of bonus depreciation. For this reason, it is important to be aware of the UNICAP rules, but UNICAP generally is not a reason to elect out of bonus depreciation. UNICAP also presents some complexity in computing taxable income in states where bonus depreciation is not allowed.
Another consideration is that for 2018, taxpayers with $25 million or less in gross receipts will be exempt from the UNICAP rules. This rule is expected to require filing a tax method change in order to apply the new rules under the TCJA.
One final point to consider is that assets eligible for small-business expensing under IRC Section 179 are not capitalized as UNICAP costs. Section 179 expensing allows taxpayers to deduct up to $1 million of qualified fixed assets placed in service during the tax year, with the deduction phased out as qualified property exceeds $2.5 million. Taxpayers eligible for a Section 179 expensing election might want to use it for some or all of their assets placed in service during the year to reduce the impact of UNICAP on their bonus depreciation costs.