Bonus depreciation is a powerful tax incentive that lets businesses immediately deduct a large percentage of the purchase price of eligible assets, such as machinery, instead of spreading the write-off over the asset’s useful life. Commonly known as the additional first-year depreciation deduction, this provision can significantly impact your tax obligations.
Key Takeaways
- Bonus depreciation enables businesses to deduct a substantial part of the cost of eligible assets in the acquisition year, rather than depreciating them over several years.
- It was introduced to encourage small business investments and stimulate the economy.
- Businesses should use IRS Form 4562 to record bonus depreciation alongside other types of depreciation and amortization.
- Rules and limits for bonus depreciation have evolved and the current provisions are set to change by 2023.
- In 2022, bonus depreciation allows for 100% upfront deductibility; decreasing annually until it phases out in 2027.
Understanding Bonus Depreciation
When a business acquires an asset, the usual tax treatment spreads the cost over its useful life, termed as depreciation. Depreciation reduces a company’s net earnings, which in turn may lower its tax liability.
Bonus depreciation allows businesses to deduct significant costs upfront, reducing taxable net income. Congress crafted these rules to let companies deduct a fixed percentage of an asset’s cost upfront rather than using traditional depreciation schedules. Although the total depreciation expense over an asset’s life remains identical, front-loading the deductions can enhance immediate tax savings. For instance, deducting $10,000 annually over 10 years has a different tax impact compared to deducting $100,000 in a single year.
The Tax Cuts and Jobs Act of 2017 made significant updates, doubling the bonus depreciation from 50% to 100% and extending benefits to certain used properties under specific conditions.
History of Bonus Depreciation
Bonus depreciation reached its 20th anniversary recently. Over time, the eligibility criteria and depreciation rates have shifted, with the benefit extended multiple times. A summary of the associated legislation includes:
| Legislation | Notes |
|---|---|
| Job Creation and Worker Assistance Act (2002) | Introduced bonus depreciation allowing 30% deduction on eligible assets’ costs. |
| Jobs and Growth Tax Relief Reconciliation Act (2003) | Increased the bonus depreciation rate to 50%. |
| Economic Stimulus Act (2008) | Maintained the rate at 50%, extending the program. |
| Protecting Americans from Tax Hikes (2015) | Extended the program through 2019, phasing out post-2017. |
| Tax Cuts and Jobs Act (2017) | Elevated the rate to 100%, extending the program through 2026. |
Qualifying Assets for Bonus Depreciation
To qualify, an asset must have a useful life of 20 years or less and can be used for business or personal purposes. The Tax Cuts and Jobs Act further revised acquisition eligibility such as:
- The asset was not previously used by the taxpayer.
- The asset was not acquired from a related party.
- The asset wasn’t previously owned by a controlled group member of the seller’s corporation.
- The abashed value does not refer to the seller’s property basis.
- The basis isn’t based on property inherited from a decedent.
New revisions also opened eligibility for specific assets, such as qualified film, television, or theater property, purchased post-September 27, 2017.
Disqualified Assets
Certain assets are ineligible for claim, including:
- Primarily utility-related assets for selling or furnishing power, gas, or water.
- Assets used in entities with significant floor-plan financing.
- Certain qualified improvement properties acquired post-December 31, 2017.
For precise information and personalized advice, it’s advisable to consult a tax expert specializing in bonus depreciation.
How to Report Bonus Depreciation
Report bonus depreciation using IRS Form 4562, which includes other depreciation types. Taxpayers need to calculate their bonus depreciation value to report the “special depreciation allowance” under Part II, Line 14. The depreciable base is figured after any credits or deductions applied. Special mergers or acquired property via like-kind exchanges or involuntary conversions have unique considerations.
Election Out
Taxpayers preferring traditional depreciation schedules can opt out of the special depreciation allowance by attaching an identifying statement to their tax returns. Once elected, this decision cannot be reversed without IRS approval.
Recapture
Property disposed of after claiming a special depreciation deduction must recognize potential ‘recaptured’ amounts as income, impacting ordinary taxes.
Bonus Depreciation Schedule and Phase-Out
The current rules are effective for property acquired and put in service post-September 27, 2017, until January 1, 2023. The depreciation rates will phase out by 2027:
| Year the Asset Placed in Service | Bonus Depreciation Rate |
|---|---|
| 2022 | 100% |
| 2023 | 80% |
| 2024 | 60% |
| 2025 | 40% |
| 2026 | 20% |
| 2027 | 0% |
Bonus Depreciation vs. Section 179
Bonus depreciation and Section 179 deductions are often used together. Section 179 allows depreciation on assets used more than 50% for business, subject to a dollar limit, offering flexibility in deferring unused periods to future tax years.
Bonus depreciation isn’t capped and can accommodate significant deductions in one year but lacks timing flexibility. Conversely, Section 179 capped at $1,080,000 for 2022 (on up to $2,700,000 of assets). It’s possible to leverage both in the same tax year, applying to distinct assets to maximize benefits.
The Benefits of Bonus Depreciation
Bonus depreciation provides immediate tax relief by deducting asset costs in the acquisition year, which can dramatically lower a company’s taxes. This translates to effective tax strategy acceleration, improving cash flow for other investments.
Do Vehicles Qualify for Bonus Depreciation?
Yes, businesses can wholly deduct the cost of vehicles or trucks under bonus depreciation rules (differed slightly than Section 179 with luxury voiture limits on deductible amounts).
Should I Take Bonus Depreciation?
Opting for bonus depreciation reduces short-term tax liabilities and may result in a net business loss that carries forward. Evaluating against electing-out scenarios with professional advice safeguards it fits your tax strategy.
What Assets Qualify for Bonus Depreciation?
Eligible properties include MACRS property under 20 years in life, certain depreciable software, or qualifying leasehold improvements, now aligning new criteria of acquisition basis calculations.
The Bottom Line
Bonus depreciation is a proactive tax management tool for businesses investing in utility assets. It offers comprehensive initial year deductions but is set to phase out starting 2023. Ensuring proper utilization against Section 179 can enhance its strategic tax benefits.
Related Terms: Section 179, depreciation, Tax Cuts and Jobs Act, IRS Form 4562, capital expenditures.
References
- Internal Revenue Service. “New Rules and Limitations for Depreciation and Expensing Under the Tax Cuts and Jobs Act”.
- Internal Revenue Service. “Instructions for Form 4562”.
- United States Congress. “Public Law 115-97 - Dec. 22, 2017,” Page 53.
