Understanding Bonus Depreciation

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Understanding Bonus Depreciation

Let me explain bonus depreciation to you directly—it's a tax break that lets your business write off a big chunk of the cost of eligible assets right in the year you buy them, instead of spreading it out over time like regular depreciation. Think of it as an accelerated deduction to cut your taxable income fast.

What Bonus Depreciation Really Means

Bonus depreciation, or the additional first-year depreciation deduction, is a straightforward tax incentive. You can deduct a large percentage of the purchase price for things like machinery immediately, rather than depreciating them evenly over their useful life. This was designed to push businesses, especially smaller ones, to invest more. When you file, you'll use IRS Form 4562 to claim this along with other depreciation types.

The Tax Benefits and Phaseout Details

With bonus depreciation, you're accelerating your tax deduction instead of spreading the asset's cost over its life, which lowers your net earnings and tax bill right away. The Tax Cuts and Jobs Act of 2017 bumped it up from 50% to 100% for qualified property, and it even includes used items under specific rules. But remember, the rate depends on when you put the asset into service, and it's set to phase out completely by 2027. These rules can get tricky and might change, so I recommend checking with a tax advisor who knows this area well.

Bonus Depreciation Phaseout Schedule

2022: 100%
2023: 80%
2024: 60%
2025: 40%
2026: 20%
2027: 0%

A Quick History of Bonus Depreciation

Bonus depreciation started back in 2002 and has evolved with various laws. It began with the Job Creation and Worker Assistance Act allowing a 30% deduction before standard methods. Then in 2003, the Jobs and Growth Tax Relief Reconciliation Act raised it to 50%. The Economic Stimulus Act in 2008 kept it at 50% and extended it. By 2015, the Protecting Americans from Tax Hikes Act extended it through 2019 with a phaseout after 2017. Finally, the 2017 Tax Cuts and Jobs Act pushed it to 100% and extended it to 2026.

What Assets Qualify

Not every asset qualifies for bonus depreciation—it's limited to certain business items. Tangible property needs a useful life of 20 years max. Under the 2017 Act, it can't be something you used before buying, or acquired from a related party, or from a controlled group member. The basis isn't based on the seller's adjusted basis or from a decedent. The IRS says qualifying property includes tangible items under MACRS with 20 years or less life, certain software, water utility property, and qualifying film, TV, or theatrical productions.

Assets That Don't Qualify

Some assets are straight-up disqualified. This includes those mainly used for furnishing or selling electrical energy, water, sewage services, or gas/steam through systems or pipelines. Also out are items in trades with floor-plan financing under certain conditions, and qualified improvement property like leasehold improvements after December 31, 2017.

How to Report It on IRS Form 4562

You report bonus depreciation on IRS Form 4562, which covers depreciation and amortization, including listed property. To calculate the depreciable base, subtract any credits or deductions from the asset's basis. There are special rules for assets from like-kind exchanges or involuntary conversions. If you think it's better to depreciate over time, you can elect out by attaching a statement to your return specifying the property class to exclude—once done, you can't change it without IRS approval. Also, if you sell property you claimed this on, you might have to recapture some as ordinary income.

Bonus Depreciation Compared to Section 179

Section 179 lets you deduct more for qualifying property in the year it's placed in service, and it's more flexible—you can save assets for later or claim partial costs. Bonus depreciation has fixed percentages but no dollar cap, so you could deduct millions on one asset. Section 179 is capped—for 2023, it's $1,160,000 max, reduced if costs exceed $2,890,000, and $28,900 for SUVs. Section 179 is limited to your business income, but bonus depreciation isn't, and you can use both in the same year.

Do Vehicles Qualify and Why Opt Out

Yes, vehicles qualify for bonus depreciation, but there's a limit—for 2024, it's $20,400. You might opt out if you want to minimize short-term taxes, even if it means higher future liabilities or creating a net loss to carry forward. Sometimes spreading deductions makes more sense for your situation.

Wrapping It Up

In the end, bonus depreciation is a solid tax incentive for businesses buying new assets, similar to Section 179 but with potentially higher limits in some cases. It's on track to phase out by 2027, so plan accordingly.

Understanding Bonus Depreciation

Highlights