Bonus depreciation
Bonus depreciation is a tax incentive designed to stimulate business investment by allowing companies to accelerate the depreciation of qualifying assets, such as equipment, rather than write them off over the useful life of the asset. This strategy can reduce a company's income tax, which in turn reduces its tax liability.
What is bonus depreciation?
Bonus depreciation — also known as the additional first-year depreciation deduction or the 168(k) allowance — accelerates by allowing businesses to write off a large percentage of an eligible asset's cost in the first year it was purchased. The remaining cost can be deducted over multiple years using regular depreciation methods until it phases out.
The passage of the Tax Cuts and Jobs Act (TCJA) in 2017 significantly changed the rules for bonus depreciation by allowing businesses to immediately write off 100% of the cost of eligible property acquired and placed in service after September 27, 2017, and before January 1, 2023. Prior to TCJA, it was 50%.
The 100% write-off of eligible property expired December 31, 2022. Unless the law changes, the bonus percentage will decrease by 20 points each year for property placed in service after December 31, 2022, and before January 1, 2027. The phase-out schedule is as follows:
- 2022: 100%
- 2023: 80%
- 2024: 60%
- 2025: 40%
- 2026: 20%
- 2027: 0%
How does bonus depreciation work?
Bonus depreciation works by first purchasing qualified business property and then putting that asset into service before year-end.
Bonus depreciation is then reported to the IRS.
For example, if a business purchased new computer software in December 2023 but didn’t put it into service until January 2024, it would be required to wait until it filed its 2024 tax return to claim bonus depreciation on the software. Since the bonus depreciation phase-out begins in January 2024, the business would then be eligible for 60% bonus depreciation — not 100%.
For more information, check out the accountants’ guide to calculating depreciation for different property types.
What are the tax benefits of bonus depreciation?
Bonus depreciation is an important tax-saving tool for businesses, allowing them to take an immediate deduction on the cost of eligible business property in the first year. This lowers a company’s tax liability because it reduces its taxable income.
What qualifies for bonus depreciation?
In order to qualify for bonus depreciation deduction, certain criteria must be met. Qualifying assets can include:
- Modified Accelerated Cost Recovery System (MACRS) property with a recovery period of 20 years or less. This includes such property as computer equipment and office furniture.
- Depreciable computer software.
- Water utility property.
- Qualified leasehold improvement property, like any improvement to the interior portion of a nonresidential building. The improvement must be placed in service more than three years after the date the building was first placed in service.
- Costs of certain film, television, and live theatrical productions.
- Vacation property if a taxpayer uses the vacation property as a short-term rental, such as an Airbnb, etc. The passage of the TCJA created the property class known as Qualified Leasehold Improvement Property. If the short-term rental is a commercial property and the taxpayer improves the interior of the building, it may qualify for bonus depreciation.
- Residential rental estate if the taxpayer conducts a cost-segregation study.
- Vehicles which have a useful life of 20 years or less.
- Used equipment if it was not used by the taxpayer at any time prior to the acquisition.
Additional information about eligibility requirements can be found at Proposed Treas. Reg. § 1.168(k)-2(b)) and on the IRS’ additional first-year depreciation deduction FAQ page.
What is the difference between bonus depreciation and section 179?
While bonus depreciation and Section 179 are both immediate expense deductions, bonus depreciation allows taxpayers to deduct a percentage of an asset’s cost upfront. In contrast, Section 179 allows taxpayers to deduct a set dollar amount. There are additional notable differences.
- Section 179 has a limit on the annual deduction. In 2022, the maximum Section 179 expense deduction was $1,080,000. To take the full deduction, the purchase price of the eligible property cannot exceed $2,700,000. For tax years beginning in 2023, the maximum Section 179 expense deduction is $1,160,000. This limit is reduced by the amount by which the cost of section 179 property placed in service during the tax year exceeds $2,890,000. Bonus depreciation has no annual limit on the deduction.
- Section 179 deductions are also limited to annual taxable business income, meaning that a business cannot deduct more money than it made. Bonus depreciation does not have this limit and can be used to create a net loss.
Businesses may be able to combine bonus depreciation and Section 179 deductions to claim both deductions in the same tax year. As bonus depreciation phases out in the coming years, some taxpayers may be able to maintain some initial-year expensing through Section 179 rules.
How do you calculate bonus depreciation?
To calculate the bonus depreciation, you need to multiply the bonus depreciation rate — which is prevailing in the market — by the cost of the business asset. Then, deduct the tax of the property from the cost of the asset.
For example:
- Amount of bonus depreciation: Cost of asset $1,000,000 x 21% tax rate = $210,000 bonus depreciation can be claimed
- Cost of asset $1,000,000 - $210,000 bonus depreciation = $790,000 depreciated value of the asset
How do you report bonus depreciation?
To report a bonus depreciation, the election must be made by filing a statement with IRS Form 4562, “Depreciation and Amortization,” by the due date — including extensions — of the Federal tax return for the taxable year in which the qualified property is placed in service by the taxpayer.
Can bonus depreciation create a loss?
Yes, bonus depreciation can be used to create a net loss. If the bonus depreciation deduction creates a net operating loss for the year, the company can carry forward the net operating loss to offset future income.
Is bonus depreciation subject to recapture?
Yes, when the property for which bonus depreciation was claimed is sold, that depreciation is recaptured and taxed as regular income. However, there’s a cap on the tax rate of 25%.
When does bonus depreciation expire?
Unless the law changes, the bonus depreciation percentage will decrease by 20 points each year over the next several years until it phases out entirely for property placed in service after December 31, 2026. Bonus depreciation will be 0% for property placed in service on January 1, 2027, and later.
Which states allow bonus depreciation?
The state tax treatment of bonus depreciation provisions depends on the state’s conformity to the Internal Revenue Code (IRC) and each state’s decoupling provisions.
States follow different approaches in adopting conformity to the IRC, resulting in inconsistent state tax treatment of federal expensing and bonus depreciation rules. Some states conform to the current IRC, for example, Colorado, Kansas, and Louisiana; other states have decoupled from the IRC provisions, for example, Illinois, New Jersey, New York, and Pennsylvania; and others have enacted legislation that allows partial conformity or conformity in some but not all tax years covered by the federal rule, for example, Arkansas, Connecticut, and Kentucky.
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