1) First of all, what is bonus depreciation?
Designed to stimulate investment in business property (not land or buildings), the Internal Revenue Code, under the Tax Cuts and Jobs Act of 2017 (TCJA), now permits “bonus depreciation” of up to 100% of the cost of eligible business property. Prior to the TCJA, the Code permitted up to a 50% deduction.
Bonus depreciation is a method of accelerated depreciation. The IRS often calls bonus depreciation a “special depreciation allowance.” The code provision permitting this deduction is § 168(k).
So now, in the year 2021, businesses may potentially receive a 100% deduction of the cost of “qualified business property”—after first applying any applicable §179 deductions. This “immediate” depreciation deduction is available for eligible property placed in service between September 27, 2017, and January 1, 2023.
After January 1, 2023, the 100% deduction will be phased down per the following schedule:
- 2023: 80%
- 2024: 60%
- 2025: 40%
- 2026: 20%
2) Which assets are subject to bonus depreciation?
Qualified business property that has a useful life of 20 years or less. Examples include equipment, furniture, fixtures, machinery, computer software, and costs of qualified film or television productions and live theatrical productions.
Qualified business property also includes “qualified improvement property,” which are improvements made to the interior of commercial buildings. It will also apply to some “listed property,” which is property used for both personal and business (i.e., vehicles and cameras).
The property must be used in your business or in an income-producing activity. The property must have a determinable useful life and be expected to last more than one year.
3) Must the property be new, or can bonus depreciation apply to used property?
The property may be used, but new to the taxpayer. For example, bonus depreciation would not apply if you were to buy the property after leasing it. Nor will this deduction apply in transactions between related parties (including from a component member of a controlled group of corporations) or in the context of a like-kind exchange (a tax-free exchange).
4) Must I claim bonus depreciation, or may I use a different depreciation method?
Bonus depreciation is not mandatory. You’d consider timing when deciding whether to apply this deduction. When would this large tax deduction benefit your business? For example, a growing company with a low net income may prefer to spread out those deductions over the asset’s useful life to better use the deduction against income.
5) When may I claim the bonus depreciation deduction?
You claim it during the taxable year in which the asset is “placed in service” (i.e., when you put the asset to use). For example, if you purchase a copy machine in year one but start using it in year two, you claim bonus depreciation in year two.
6) Is bonus depreciation under §168(k) the same as a §179 expense deduction?
No. These code sections are slightly different in function and, therefore, produce different results. First, you apply your § 179 deduction, which has a $1 million limitation that’s proportionately reduced to the extent that the § 179 property cost exceeds $2.5 million.
Secondly, § 179 cannot create a net loss for your business income. For example, if you have $10,000 in business income and you want to expense $20,000 of § 179 property, you may only deduct 10,000. Contrarily, there is no business income limitation for bonus depreciation. So, using the preceding example, you’d be able to use a $10,000 loss.
7) How may I claim bonus depreciation?
You claim your bonus depreciation on line 14 of Form 4562. Here are the instructions for that form.
8) What are 10 things people don't know about bonus tax depreciation?
Used Property Qualifies: Many believe that only new property qualifies for bonus depreciation. However, under the Tax Cuts and Jobs Act (TCJA), used property can also qualify as long as it's "new" to the taxpayer.
No Business Income Limitation: Unlike the Section 179 deduction, which can't create a net operating loss, bonus depreciation can result in a net operating loss. This means a business can have a loss due to the bonus depreciation and carry it forward or back, depending on the tax year.
Land Improvements Qualify: While land itself does not qualify for bonus depreciation, certain improvements to the land, like landscaping, grading, and irrigation systems, can qualify.
Alternative Depreciation System (ADS): Businesses that opt for the Alternative Depreciation System (usually due to business use percentage requirements or the listed property rules) cannot claim bonus depreciation on that property.
Phase-Down Period: Post-2022, the bonus depreciation percentage starts to decrease. It's set at 80% for property placed in service in 2023 and 60% in 2024, and it continues to decrease by 20% each year until it phases out.
Certain Fruit or Nut Plants Qualify: Trees or vines that bear fruits or nuts and are planted or grafted to a plant that has already been planted qualify for bonus depreciation. This is provided they are used in the trade or business of farming.
Not All States Conform: While bonus depreciation is a federal provision, not all states conform to the federal bonus depreciation rules. This can lead to differences in taxable income for state and federal purposes.
Election Out Option: Taxpayers can choose to elect out of bonus depreciation for any class of property for any tax year. This might be strategic in certain situations where a business might want to spread out deductions over several years.
Mixed-Use Property: For properties used both personally and for business, bonus depreciation can only be claimed on the business-use portion, provided the business use exceeds 50%.
Residential Rental Property: While residential rental property typically depreciates over 27.5 years and doesn't qualify for bonus depreciation, certain improvements made to the property, like appliances or a new roof, might qualify.
New for 2023: Implications of the Phase-Down
As we move into 2023, the 80% deduction rate signifies the start of the phase-down period. It's crucial for businesses to revisit their asset purchase strategies. For long-term planning, consider the diminishing rates in the coming years and how they might impact your tax benefits.
Potential Legislative Changes
It's worth noting that tax laws are subject to change. Stay informed by consulting with a tax professional and keeping an eye on legislative updates that might affect the bonus depreciation provision.
Final Thoughts
Bonus depreciation is a robust tool for businesses to manage their tax liabilities. As we progress through its phase-down period, adapting to the changing rates and understanding the nuances becomes vital.