What is bonus depreciation?
Depreciation allows a business to write off the cost of an asset over its useful life, or the number of years the asset will be used in the business. For example, if you purchase a $10,000 piece of machinery that you’ll use for ten years, rather than expense the full $10,000 in year one, you might write off $1,000 per year for ten years.
That $1,000 write-off is nice, but it might not be enough of an incentive to encourage you to reinvest in your business–and Congress wants business owners to stimulate the economy by purchasing assets. That’s why they invented bonus depreciation.
Bonus depreciation is a way to accelerate depreciation. It allows a business to write off more of the cost of an asset in the year the company starts using it.
Thanks to the Tax Cuts and Jobs Act of 2017 (TCJA), a business can write off up to 100% of the cost of eligible property purchased after September 27, 2017 and before January 1, 2023, up from 50% under the prior law. However, that 100% limit begins to phase down after 2022. Starting in 2023, the rate for bonus depreciation will be:
- 2023: 80%
- 2024: 60%
- 2025: 40%
- 2026: 20%
How bonus depreciation works
To take advantage of bonus depreciation:
Step 1: Purchase qualified business property.
Qualified business property includes:
- Property that has a useful life of 20 years or less. This includes vehicles, equipment, furniture and fixtures, and machinery. It doesn’t include land or buildings.
- Qualified improvement property. This includes improvements made to the interior of “nonresidential real property” (also known as a commercial building), as long as the improvement is made after the building is open for business.
- Computer software.
- Some listed property. Listed property includes property that tends to be used for both business and personal use, such as vehicles and cameras. To qualify for bonus depreciation, the asset has to be used for business at least 50% of the time.
- Costs of qualified film or television productions and qualified live theatrical productions.
Step 2: Place the property in service
Placing property in service means you have to start using the asset in your business. For example, if you purchase a piece of machinery in December of 2023, but don’t install it or start using it until January of 2024, you would have to wait until you file your 2024 tax return to claim bonus depreciation on the machinery.
Step 3: Claim bonus depreciation on your tax return
You can write off up to 100% of the cost of the asset on Form 4562, which gets filed along with your business tax return.
Frequently asked questions about bonus depreciation
Depreciation is complicated, so many business owners have questions about when and how bonus depreciation applies to their business. Here are some common ones.
Do I have to take bonus depreciation?
If you purchase depreciable property in your business, depreciating the property isn’t optional–it’s required.
But bonus depreciation isn’t mandatory. If you purchase property that qualifies for bonus depreciation, and for whatever reason don’t want to write off 100% of the cost, you can elect not to take it. Instead, you can use the applicable MACRS depreciation method instead.
Is bonus depreciation the same as Section 179?
Business owners often confused bonus depreciation with the Section 179 deduction because they both allow a business to write off the cost of qualified property immediately. While these two tax breaks serve a similar purpose, they aren’t the same.
A business can’t claim Section 179 unless it has a taxable profit. For example, if your business has $5,000 of taxable income before taking the Section 179 deduction into account, and you purchase a $10,000 piece of machinery, your Section 179 deduction is limited to $5,000. At that point, you can opt to claim regular depreciation on the remaining $5,000 or carry your unused Section 179 deduction forward and deduct it in a future tax year.
On the other hand, bonus depreciation isn’t limited by the business’ taxable income. Returning to the previous example, you could take a Section 179 deduction of $5,000 to reduce your taxable income to zero, then take bonus depreciation for the remaining $5,000.
Are there different bonus depreciation rules for vehicles?
Depending on the type and size of the vehicle, there may be different bonus depreciation limits. The IRS sets different limits for vehicles to keep people from claiming large tax deductions on luxury cars or ones that are used mainly for personal driving.
For example, vehicles with a gross vehicle weight (GVW) of 6,000 pounds or less that limited to $8,000 of bonus depreciation in the first year they’re placed in service.
On the other hand, heavy vehicles with a GVW rating above 6,000 pounds that are used more than 50% for business can deduct 100% of the cost.
Can I claim bonus depreciation on used property?
The TCJA expanded the definition of qualified property to include used property. Previously, only new assets were eligible for bonus depreciation.
However, to be eligible for bonus depreciation, the property must meet the following requirements:
- The taxpayer didn’t use the property at any time before acquiring it. For example, if your business leases a piece of equipment before purchasing it, you would not be able to claim bonus depreciation on the equipment.
- The taxpayer didn’t acquire the property from a related party.
- The taxpayer didn’t acquire the property as part of a tax-free transaction, such as a like-kind exchange.
Bonus depreciation can be a valuable tax break for businesses that purchase furniture, equipment, and other fixed assets. However, depreciation laws and limits are always changing.
Before you decide to buy property, it’s a good idea to talk to your tax professional to be sure you’re making the right move for your business.