What is bonus depreciation (plain language)
– Bonus depreciation is an accelerated tax write‑off that lets a business deduct a large portion — sometimes the entire cost — of certain qualifying business property in the year the asset is placed in service, rather than spreading that cost across the asset’s useful life using normal depreciation schedules.
Key elements and how it works
– Purpose: accelerate tax deductions to lower taxable income sooner after a purchase of eligible assets.
– Eligible property (common categories): tangible property subject to MACRS (the IRS Modified Accelerated Cost Recovery System) with a recovery period of 20 years or less, certain off‑the‑shelf computer software, qualifying water utility property, and certain film/TV/theatrical productions.
– Timing and percentage: the allowable bonus percentage depends on when the property was placed in service. The Tax Cuts and Jobs Act expanded bonus depreciation (initially to 100% for eligible property) and also allowed used property to qualify under specified conditions. The bonus deduction is scheduled to phase down by 2027, so the exact percent depends on the placement date.
– Reporting: claim bonus depreciation on IRS Form 4562 (Depreciation and Amortization).
– Basis adjustments: compute the depreciable basis after subtracting any credits or other deductions allocated to the property.
– Interaction with other rules: assets acquired in a like‑kind exchange or an involuntary conversion may have special basis rules.
– Recapture: if you sell property for which you took bonus depreciation, some or all of the earlier deduction may have to be recaptured as ordinary income.
Simple definitions (jargon explained)
– Depreciation: the method of allocating the cost of a business asset over its useful life for tax and accounting purposes.
– MACRS: Modified Accelerated Cost Recovery System — the IRS’s standard depreciation framework specifying recovery periods and conventions.
– Section 179 deduction: a separate provision that allows businesses to elect to immediately expense qualifying property up to statutory dollar limits and subject to income and investment thresholds.
How bonus depreciation differs from Section 179 (brief)
– Bonus depreciation can be taken for qualifying property without an annual dollar cap and
and it is generally available for both new and (in many cases) used qualifying property placed in service after September 27, 2017. Below I continue with practical rules, examples, and a short checklist you can use when evaluating bonus depreciation.
Key rules and definitions (practical)
– Qualified property: tangible property with a recovery period of 20 years or less (for example, machinery, equipment, furniture), certain computer software, and “qualified improvement property” (QIP). Buildings and land are not eligible. Check the IRS class life to confirm.
– Placed in service: bonus depreciation applies in the year the asset is first ready and available for use, not necessarily when you pay for it.
– Amount of bonus: under the Tax Cuts and Jobs Act (TCJA) the bonus was 100% for property placed in service through 2022. The statute phases down thereafter: 80% for property placed in service in 2023, 60% in 2024, 40% in 2025, 20% in 2026, and 0% for 2027 unless Congress extends or changes the rules. (Confirm current law for the year you are filing.)
– Interaction with Section 179: Section 179 is an election to immediately expense qualifying property subject to dollar limits and taxable income limitations. Bonus depreciation is taken after the Section 179 election and is not subject to the annual dollar limit, but bonus is
not limited by the annual Section 179 dollar cap. In practice that means you first apply any Section 179 election (subject to its dollar and income limits), and then you may apply bonus depreciation to the remaining depreciable basis of qualifying property. You can, however, elect out of bonus depreciation for any class of property for a tax year if you prefer to use regular MACRS depreciation instead.
Key practical points and rules
– Eligible property: Bonus generally applies to most tangible property with a recovery period of 20 years or less (machinery, equipment, computers), certain computer software, water utility property, and qualified improvement property (QIP). QIP was made 15-year property by later legislation and generally became eligible for bonus depreciation. Check the precise IRS definitions for each class.
– New and used property: Under changes enacted with the Tax Cuts and Jobs Act, bonus depreciation can apply to certain used property as well, provided it meets the “new to the taxpayer” requirement.
– Phase-out schedule: The percent allowed for bonus depreciation has ranged by tax year (100% through 2022 under the TCJA, then phased down in later years unless changed by Congress). Always confirm the percentage for the tax year in which the property is placed in service.
– Electing out: A taxpayer may elect out of bonus depreciation for any class of property for a tax year (typically by making an election on the tax return). If you want to defer deductions, electing out may be appropriate.
– Business-use percentage: Depreciation (Section 179 and bonus) is limited to the portion of the asset used for business. Personal-use portions are not eligible.
– Passenger vehicle limits: “Luxury auto” rules put relatively low caps on depreciation deductions (including bonus) for passenger cars; special limits apply to vehicles used predominantly in business.
– State tax treatment: Many
State tax treatment: Many states do not fully conform to the federal bonus depreciation rules. Some states decouple entirely and require taxpayers to add back the federal bonus deduction when computing state taxable income; others conform but phase in conformity or require a carryforward of the disallowed amount. Because state rules vary and can change, check your state’s revenue department guidance before relying on federal bonus depreciation for state tax planning.
Interaction with Section 179 (expensing) — quick comparison
– Section 179 allows an immediate deduction for the cost of qualifying property up to a statutory limit in the year the property is placed in service. It is subject to business-income and dollar limits and can be allocated among multiple assets.
– Bonus depreciation (Section 168(k)) is an additional first-year depreciation percentage applied after any Section 179 election. It generally has no business-income limitation and can create or increase a net loss.
– Typical planning: elect Section 179 for vehicles or assets you want limited to business-income levels (or to avoid creating an NOL), then use bonus depreciation on remaining qualifying property where you want the largest immediate write-off.
Making the election out of bonus depreciation
– When: You may elect out of bonus depreciation for any class of property for a tax year; that election is generally made on the timely filed tax return for that year.
– How: The election is typically made by a statement attached to the return (often in connection with Form 4562, Depreciation and Amortization) identifying the class of property and stating the election to forgo bonus depreciation for that class. Once made for a class in a year, the election is generally irrevocable without IRS consent.
– Why: Elect out when you want to spread deductions over future years (for taxable income smoothing), reduce current-year losses, or coordinate with state tax rules that do not allow federal bonus depreciation.
Practical numeric example (illustrative, simplified)
Assumptions: Business buys qualifying 5-year property for $100,000; business use 100%; bonus depreciation = 80% (as might apply in a phase-down year). MACRS multi-year depreciation details are simplified for clarity.
Scenario A — Take bonus depreciation (80%):
– Year 1 bonus deduction: $100,000 × 80% = $80,000.
– Remaining basis to depreciate: $20,000; spread over remaining MACRS recovery (approx. $4,000/year if using a 5-year straight simplification).
– Year 1 total approx deduction: $80,000 + a small MACRS amount ≈ $84,000.
Scenario B — Elect out of bonus depreciation:
– Depreciate full $100,000 over the 5-year schedule (simplified): $100,000 ÷ 5 = $20,000/year.
– Year 1 deduction: $20,000.
Comparison (Year 1): Scenario A gives a much larger immediate deduction ($~84k vs $20k). Over the entire recovery period, total deductions equal cost basis in both cases (ignoring salvage and conventions), but timing differs, affecting current taxable income and possible NOLs, AMT implications, and state tax adjustments.
Recordkeeping and compliance checklist
– Invoice and purchase contract showing cost and date placed in service.
– Evidence of business-use percentage (mileage logs, usage schedules).
– Asset class identification (7-year, 5-year, 3-year property, etc.).
– Form 4562 filed with tax return (depreciation schedule and any Section 179 election).
– If electing out: attach required election statement to tax return and retain proof of timely filing.
– Track state adjustments: maintain worksheets for federal-to-state addbacks or carryforwards.
Common planning considerations and pitfalls
– Business-use percentage: Only the business portion qualifies. If business use drops, you may need to recapture depreciation and adjust basis.
– Passenger vehicle limits: “Luxury auto” limits cap depreciation (including bonus) for passenger vehicles; special rules apply to certain heavy SUVs and trucks.
– Net operating losses (NOLs): Large bonus deductions can create or increase NOLs; rules governing NOL carryforwards are complex
– Disposition and recapture: If you sell, trade, or stop using depreciable business property, some or all of prior depreciation (including any bonus-depreciation amounts) can be “recaptured” as ordinary income under Section 1245 for personal property (equipment, most nonresidential tangible property) and Section 1250 for certain real property. Recapture means the IRS treats previously allowed depreciation as ordinary income to the extent of the gain on disposition. The fact that you claimed bonus depreciation does not eliminate recapture — it simply increases the pool of depreciation that may be recaptured. Keep acquisition, disposition, and basis records to calculate recapture correctly when property is sold or converted to personal use.
– Change in business usage (business-use percentage): Depreciation deductions — including bonus — generally apply only to the portion of an asset used for business. If business use later falls (for example, you convert equipment to 50% business use), you generally must recapture the portion of depreciation that exceeds the allowable deduction under the new business-use percentage and adjust the asset basis going forward.
– Listed property and luxury auto limits: “Listed property” (items that can be used for both business and personal purposes, such as computers and vehicles) carries tight substantiation requirements. Passenger autos face annual luxury
auto limits” — annual caps on depreciation (including any bonus depreciation) for passenger vehicles used in a business. Because these caps can substantially reduce the first-year write-off for cars and light trucks, confirm the applicable annual dollar ceilings for the tax year before assuming you can expense the entire cost.
Checklist: what to watch for with bonus depreciation
– Qualified property: is the asset new or used and otherwise eligible under §168(k)? (Consult the statute or your tax advisor for edge cases.)
– Placed-in-service date: bonus percentages and eligibility depend on the tax year the asset was placed in service.
– Business-use percentage: depreciation (including bonus) applies only to the business portion of use.
– Interaction with Section 179: Section 179 election is applied before bonus depreciation; both cannot double-count the same basis.
– Listed property and autos: stricter substantiation and annual limits may apply.
– State conformity: many states do not follow federal bonus depreciation; plan for state additions or spreads.
– Recordkeeping: acquisition docs, invoice showing cost, evidence of business use (mileage logs, allocation agreements), and disposition records.
Step-by-step: claiming (or declining) bonus depreciation — practical approach
1. Identify eligible assets and determine the basis for each (generally cost plus any capitalizable costs).
2. Allocate business-use percentage. If less than 100%, multiply basis by business-use percentage to get basis eligible for depreciation.
3. Apply Section 179 election first (optional). Any basis you elect to expense under Section 179 reduces the remaining depreciable basis.
4. Apply bonus depreciation to the remaining eligible basis: bonus deduction = eligible basis × bonus percentage (for the year).
5. Compute regular MACRS depreciation on the remaining basis after Section 179 and bonus have been applied (if any basis remains).
6. Report deductions on Form 4562 (Depreciation and Amortization) or the applicable schedule for your business entity.
7. If you wish to decline bonus depreciation for any property, attach a timely statement to the tax return for the year the property was placed in service (rules for filing the election vary by entity and can be technical — consult a tax professional).
Worked numeric example — basic
Assumptions:
– Machine cost (original basis): $100,000