As a small business owner, you want to take advantage of every available opportunity tomaximize your profitand minimize your taxes. One such opportunity is bonus depreciation. But what exactly is the bonus depreciation deduction?
It's easy to get caught up in the details, so we'll break down all you need to know: what it is, when and how much you can deduct, and what types of property qualify.
Don't worry—understanding this beneficial deduction doesn't have to be difficult! We'll provide an overview that will help make everything clear.
What is Bonus Depreciation?
Bonus depreciation is a tax incentive that allows businesses todeducta large percentage of a new piece of equipment, machinery or technology the year it's first used rather than depreciating it over several years.
This allows businesses to claim the larger deduction immediately and essentially save a lump sum on taxes.
It's designed to give businesses an incentive to invest in new capital assets (which is good for the economy) while simultaneously providing them with more cash flow. They can then use that to grow their business.
When Can You Claim It?
Bonus depreciation is available in the year the asset is placed in service. That may differ from the year it was purchased.
For example, if you buy a piece of equipment in December 2023 but don't start using it for your business until January 2024, you would have to wait to claim bonus depreciation on the equipment until you file your 2024 tax return.
How Much Can You Deduct?
For equipment put into use in 2023, you can deduct 80% of its cost from your 2024 taxes.
This is different than in years past. In fact, from September 28, 2017, through December 31, 2022, businesses could deduct 100% of the cost of qualifying property under these rules.
However, that percentage is scheduled to slowly phase out, dropping by 20% each year until bonus depreciation is eliminated in 2027.
So, unless Congress acts to change or extend this section of the tax code, the available percentages are:
- 80% in 2023
- 60% in 2024
- 40% in 2025
- 20% in 2026
- 0% in 2027 and beyond
What Types of Property Qualify for Bonus Depreciation?
Bonus depreciation is available for many types of business assets. To qualify, your property must be tangible personal property with a depreciable life of 20 years or less. This can include:
- Computer software
- Leasehold improvements
But it doesn't include land, buildings, or intangible assets, such as patents or trademarks.
In previous versions of IRS depreciation rules, used property didn't qualify for bonus depreciation. However, the Tax Cuts and Jobs Act (TCJA) of 2017 made it available for new and used property, as long as the property wasn't acquired from a related party.
The related party eligibility restrictions are meant to prevent business owners from transferring property to a related company to claim the business tax write-off twice on the same asset.
Example of How Bonus Depreciation Works
Say you purchase a piece of equipment that costs $20,000 in January 2023 and place it in service right away.
Say you follow normalmodified accelerated cost recovery system (MACRS) depreciationrules for this piece of equipment and depreciate it over seven years. Using aMACRS depreciation calculator, you discover your first-year depreciation deduction would only be about $5,476.
However, if you took advantage of bonus depreciation, your write-off would be $16,000 in the first year (80% of $20,000).
That would give you more than $10,000 in additional cash flow you could use to pay employees, pay down debt, reinvest in your business, or put to another purpose.
Pros and Cons of Bonus Depreciation
The advantages of bonus depreciation are clear: the tax savings allow your business to get more cash flow right away. This can helpjump-start growthand make the most of the purchase by deducting a larger percentage of costs in the year you place the property in service.
So, if you want to make some big investments ASAP, like innew team members, software or additional equipment, it could be really useful.
However, there are some reasons you should think twice before claiming accelerated depreciation. The downsides mostly relate totax planning.
Claiming bonus depreciation doesn't actually give you a bigger write-off than claiming regular depreciation—it's just a matter of what year you take the tax deduction in. And there can be situations in which you want to save your tax deduction for later when you might be in a higher tax bracket.
For example, say you bought that $20,000 piece of equipment in 2023 but only have a little business income to offset in 2023.
However, you know that next year you'll have a big contract come through and will have much more taxable income, pushing you into a higher tax bracket.
In that case, it might make sense not to take bonus depreciation on the equipment so that you can claim a larger deduction next year. You'd have more write-offs in year two, thus less taxable income and a smaller tax bill.
What Happens if I Don't Take the Deduction?
Bonus is the default, so if you elect out of claiming the expense deduction on one category of assets, such as 7-year equipment, then you elect out of claiming it on all assets in that category.
For example, say you don't want to take bonus depreciation on the $20,000 piece of equipment. That equipment has a seven-year recovery period—the IRS's way of saying the number of years you'd normally depreciate it over.
So you can't claim bonus depreciation on a different piece of equipment with a seven-year useful life. However, you could still claim this tax benefit for five-year property, such as a business vehicle.
To choose not to take it, you have to make an election on your federal income tax return. This simply involves attaching a statement toForm 4562—the form used to claim depreciation on your tax return.
Here's a sample election statement:
Election Out of the Special Depreciation Allowance (Bonus Depreciation)
Under IRC Section 168(k)(7)
Your Name and Social Security or Tax ID Number
Tax Year Ending 20XX
Taxpayer elects under IRS Section 168(k)(7) to not claim the additional 80% first-year bonus depreciation deduction for [class of property] placed in service during the tax year ended 20XX.
If you have a professional prepare your tax return for you, they can usually check a box to attach that election statement to your return.
Are Bonus Depreciation and Section 179 the Same?
No. Bonus depreciation andSection 179are similar in that they allow you to write off more of the cost ofassetsused in your business, but they're not the same.
Bonus depreciation allows businesses to immediately deduct up to 80% of the cost of qualifying property placed in service during the year.
Section 179 allows businesses to immediately deduct up to $1,160,000 of the cost of qualifying property acquired and placed in service during the tax year.
Unlike the Section 179 deduction, bonus depreciation is:
- Not limited to an annual dollar amount
- Not limited to your business's annual profits
- Not limited to property that is used 50% or more for business purposes
You may be able to claim both bonus depreciation and Section 179 in the same year as long as they're applied to different pieces of qualifying property.
Bonus Depreciation FAQs
Bonus depreciation is an important tax tool available to businesses that can help them save money on the purchase of qualifying property. To get the most out of this powerful deduction, we've compiled some frequently asked questions about bonus depreciation below.
Is Bonus Depreciation still 100%?
No, you can't deduct 100% of a qualifying asset that's placed in service in 2023 and beyond. For 2023, the bonus depreciation rate is 80%, and it will decrease by 20% each year until it reaches 0% in 2027. You used to be able to claim 100%—from 2017 through 2022, businesses could immediately deduct 100% of the cost of qualifying property.
Does Bonus Depreciation Apply to Used Property?
Yes. Since 2017, businesses can use bonus depreciation for both new and used qualifying property. However, the property must not have been acquired from a related party to qualify.
Can Bonus Depreciation be Used for Real Estate?
No, bonus depreciation rules only apply to tangible property with a useful life of 20 years or less. This means you can't use it on real property, including land—which isn't depreciable at all—or buildings. For tax purposes, you can depreciate residential rental property over 27.5 years and commercial buildings over 30 years.
However, qualified improvement property does qualify for bonus depreciation. This includes interior, non-structural improvements to commercial buildings made after the building was originally placed in service.
So, if you are a real estate owner who renovated one of your existing buildings, you may want to have a cost segregation study done to determine if any of those improvements qualify for immediate write-off under bonus depreciation rules.
In a cost segregation study, a team of tax advisors and engineers look at all the components of a building, such as plumbing fixtures, carpeting, and sidewalks, and work together to decide which components can be depreciated on a faster timeline than the building itself.
ManyCPA firmsoffer cost segregation studies, so check with your accountant to see if you could benefit.
Do States Allow Bonus Depreciation?
Some states allow bonus depreciation and some don't, so it's a good idea to check with your tax professional.
Grow Your Business and Boost Cash Flow with Bonus Depreciation
Overall, bonus depreciation can be an excellent way to take advantage of tax savings that help you afford new equipment and other business needs.
Still, it's a good idea to weigh the pros and cons carefully and consult a tax advisor before making any final decisions. With careful planning, you can maximize the benefits of this valuable incentive and get an immediate boost to your cash flow!
What is the bonus depreciation deduction? ›
Bonus depreciation is an accelerated business tax deduction that allows businesses to deduct a large percentage of the purchase price of eligible assets upfront. This reduces a company's income tax which, which, in turn, reduces its tax liability. Go to full Tax & Accounting glossary.Is there a limit on how much bonus depreciation you can take? ›
The rules allow Bonus Depreciation to 100% for all qualified purchases made between September 27, 2017 and January 1, 2023. Bonus Depreciation now ramps down to 80%, starting in 2023. Bonus depreciation will continue to ramp down for ensuing years: 60% for 2024, 40% for 2025, 20% for 2026, and 0% beginning in 2027.How do I calculate bonus depreciation? ›
Bonus Depreciation is calculated by using the bonus rate, which is prevailing in the market. The calculation involves multiplying the rate with the cost of the asset. The tax on the property is then deducted from the cost of the asset. On that deducted value, the additional first-year depreciation is calculated.Does bonus depreciation have to be 100 %? ›
The 100% bonus depreciation will phase out after 2022, with qualifying property getting only an 80% bonus deduction in 2023 and less in later years.When should you not take bonus depreciation? ›
Additionally, if you choose not to take 100% bonus depreciation on an asset, then you must choose not to take bonus on all other assets that have the same life (i.e., if the asset is a five (5) year asset, then you choose not to take bonus on any other five (5) year asset you acquired that year.)Should I elect out of bonus depreciation? ›
The fact that your tax return shows some lower number, such as MACRS depreciation, means nothing. If your property is eligible for bonus depreciation and you want to spread your depreciation deductions over many years, you must elect out of bonus depreciation.What are the IRS bonus depreciation rules? ›
Bonus depreciation allows a taxpayer to reduce their short-term taxable income by the cost of depreciable assets. Bonus depreciation allows a taxpayer to deduct 100% of depreciation upfront on their Federal tax return.What is 100% bonus depreciation example? ›
Bonus depreciation is calculated by multiplying the bonus depreciation rate (currently 100 percent) by the cost of the asset. For example, assuming a 21 percent tax rate, a business claiming bonus depreciation on an asset that cost $100,000 would deduct $21,000. Bonus depreciation can be used to create a net loss.Is it better to take Section 179 or bonus depreciation? ›
Section 179 offers greater flexibility but also caps the benefit. Bonus depreciation has no limitations but may force a company to “waste" depreciation that it could benefit from in future years.What is the formula for bonus calculation? ›
Basic Salary + DA < 7,000, then in such cases, Bonus Payable = (Basic Salary + DA) * Amount %, either 8.33% (establishment is supposed to give even in case of deficit) or could go up to 20% Basic Salary + DA > 7000, then in such cases, Bonus Payable= Rs.
What is the benefit of bonus depreciation? ›
Bonus depreciation in real estate allows an investor to deduct the full cost of capital improvements in the same tax year the expense is incurred. Bonus depreciation is scheduled to be phased out by the end of the 2026 tax year.Which states do not allow bonus depreciation? ›
No tax, no deductions: Nevada, South Dakota, Wyoming, and Washington have no corporate income tax, so section 179 deductions and bonus depreciation don't apply.Can you use depreciation to offset w2 income? ›
First – Depreciation, bonus, or otherwise, only offsets passive income. Passive income includes rent from investment real estate, profits from ownership in a business you don't actively participate in, etc. It does not offset ordinary income like your W-2 income.How long does bonus depreciation last? ›
Originally, the bonus depreciation rules were set to expire at the end 2019. The TCJA extended the rules and increased the top deduction benefit to 100% for certain assets placed into service between September 27, 2017 and January 1, 2023.Why would you opt out of bonus depreciation? ›
One of the biggest factors of electing out of bonus depreciation would be whether or not your company plans to make money for the year. If you are forecasting a loss for the current year, it may make sense to elect out of bonus.Can you take 50% bonus depreciation? ›
50% bonus depreciation is allowable for qualifying property placed in service during two different time periods: Property placed in service after May 5, 2003 and before January 1, 2005, and. Property placed in service after December 31, 2007 and before January 1, 2015.What is the disadvantage of Section 179 deduction? ›
Cons. Makes taxes more expensive in the future because you can't claim the property anymore. Makes taxes more complicated when the property is sold or no longer used for business purposes. Companies that spend more than $2.7 million on equipment, machinery or another investment in 2022 can't get the full deduction.Do roofs qualify for bonus depreciation? ›
Remember that the IRS classifies some additions and improvements as assets with the same recovery period as the property itself. One of those improvements or additions is a new roof. Due to this, a new roof expense on a rental property does not qualify for bonus depreciation.How do I calculate my hourly bonus? ›
To start, multiply the pay rate by the total hours worked. Then add the bonus. Then, divide that total by the number of hours worked to get the regular hourly rate of pay. Now, find the overtime hourly rate by multiplying the regular rate of pay by 1.5.What is a typical bonus amount? ›
A company sets aside a predetermined amount; a typical bonus percentage would be 2.5 and 7.5 percent of payroll but sometimes as high as 15 percent, as a bonus on top of base salary.
Is bonus calculated as salary? ›
While bonuses are subject to income taxes, the IRS doesn't consider them regular wages. Instead, your bonus counts as supplemental wages and can be subject to different federal withholding rules.What assets are eligible for 100% bonus depreciation? ›
- Property that has a useful life of 20 years or less. This includes vehicles, equipment, furniture and fixtures, and machinery. ...
- Qualified improvement property. ...
- Computer software.
- Some listed property. ...
- Costs of qualified film or television productions and qualified live theatrical productions.
You can deduct your entire Investment no matter how much you spend per year. Bonus Depreciation deduction can be larger than your business income! Unlike the Section 179 deduction, Bonus Depreciation must apply to 100% of an asset's cost and all assets must be in the same category.What is the difference between 179 and bonus depreciation? ›
So what's the difference between Section 179 and bonus depreciation? Section 179 lets business owners deduct a set dollar amount of new business assets, and bonus depreciation lets them deduct a percentage of the cost.What improvements qualify for bonus depreciation? ›
- Land improvements other than buildings, for example fencing and parking lots, and.
- “Qualified improvement property,” a broad category of internal improvements made to non-residential buildings after the buildings are placed in service.
A company can take both Section 179 and Bonus Depreciation allowances, but Section 179 must be applied first, and any amount over the $1,080,000 limit to Section 179 may then be taken in bonus depreciation. For tax year 2022, the Bonus Depreciation allowance is 100%.How much 179 depreciation can you take? ›
Section 179 deduction dollar limits.
This limit is reduced by the amount by which the cost of section 179 property placed in service during the tax year exceeds $2,700,000.Also, the maximum section 179 expense deduction for sport utility vehicles placed in service in tax years beginning in 2022 is $27,000.
Code §179 reduces taxable income and therefore amount eligible for the QBI.