Small businesses can deduct the cost of buying and using business assets by depreciating these assets over several years. The 2017 Tax Cuts and Jobs Act made changes to extend and increase benefits to businesses for buying equipment, machinery, vehicles, and other business property. These benefits come from increased write-offs on your business tax return.
This article discusses the types and amounts of accelerated depreciation, how to qualify, and how to take the deductions.
- Depreciation is the process of deducting costs for business assets over several years.
- Accelerated depreciation allows businesses to speed up all or part of these deductions, taking them in the first year the asset is bought and used.
- A small business may also qualify for additional deductions for section 179 property and a first-year bonus deduction.
- Accelerating depreciation reduces business income taxes, allowing the business to use this money for other business purposes.
How Does Accelerated Depreciation Work?
Depreciation is a deduction process that spreads the expenses of an asset over its useful life (the years it would typically be useful to the business). Ordinary (un-accelerated) depreciation is also called "straight-line" depreciation because the depreciation expense is the same each year. For example, if an asset is purchased for $10,000 and its useful life is 10 years, under straight-line depreciation, $1,000 would be written off (deducted) each year.
But some types of assets—cars, for example—depreciate faster in the first years of use. To recognize this fact, the IRS allows accelerated depreciation, which puts most of the expense of the asset in the first year it is used. This increase in expenses lowers the business's taxable income, and the resulting reduced taxes give the business more money to spend on equipment, hiring more employees, or increasing product development activities.
To be able to depreciate an asset, your business must own the asset and use it for producing income. It must be expected to last at least a year and have a specific useful lifetime.
Only business assets may be depreciated; not personal assets. If your business owns a car that is used for both business and personal driving, you can only depreciate the business costs.
How To Calculate Accelerated Depreciation
The IRS currently requires businesses to use the MACRS system for accelerated depreciation, in which asset classification determines the depreciation period. MACRS consists of two systems, each using a different method and recovery period to calculate depreciation. Businesses usually use the General Depreciation System (GDS) unless they are required to use the Alternative Depreciation System (ADS).
MACRS has four depreciation methods for calculating accelerated depreciation:
- 200% declining balance using a GDS recovery period
- 150% declining balance using a GDS recovery period
- The straight line method over a GDS recovery period.
- The straight line method over an ADS recovery period.
ADS uses the straight line (non-accelerated) method of depreciation, in which you take the same amount of depreciation in each year over the life of the asset.
Here's an example of how the 200% declining balance (sometimes called double-declining balance) works:
For an asset worth $10,000 with a useful life of 10 years, 10% of the cost ($1,000) is depreciated each year using the straight-line method. Doubling the rate (a 200% deduction) would mean that 20% ($2,000) would be depreciated each year, so the asset would be fully depreciated in five years rather than 10.
IRS Publication 946: How to Depreciate Property includes Table 4-1 that shows the type of property that can be depreciated under each method and the benefit of that method.
Your business can elect a different depreciation method for different types of property. You must make the election by the due date of the tax return for the year you place the property in service.
Section 179 Deductions and Bonus Depreciation
In recent years, two additional types of accelerated depreciation have been allowed by U.S. law: bonus deprecation and section 179 deductions.
Section 179 Deductions
Section 179 deductions can be on new or used equipment, vehicles, and other specific types of business property, but not land. Some improvements to business buildings may also qualify.
Qualifying property can be deducted, but there are limits to the total amount of section 179 property your small business can deduct each year. Beginning in 2020, the dollar limit for each item of section 179 property placed in service in a tax year is $1,040,000. In addition, there is a total limit of $2,590,000 that you can deduct for all qualifying section 179 property for that tax year.
Sport utility vehicles (SUVs) are in a special category for section 179 deductions. Your business can't expense an SUV for more than $26,200, beginning in 2021. This deduction doesn't apply to vehicles designed to seat more than nine passengers, are equipped with a cargo area, or that separate the driver and the rest of the vehicle.
The total amount of section 179 deductions is limited to the taxable income of your business from operations during the year; you can't use these deductions to take a business loss. But costs you can't deduct in one year may be carried over to the next year.
Bonus depreciation ("Special Depreciation Allowance") allows a business to get an additional deduction on qualified property in the first year it's put into service. The property must be depreciated under MACRS and have a useful life of at least five years. It's available for other categories of new property and some used property. Machinery, equipment, computers, appliances, and furniture generally qualify.
The bonus depreciation allowance is 100% for property acquired after September 27, 2017, and placed in service before January 1, 2023.
Frequently Asked Questions (FAQs)
How is accelerated depreciation calculated?
To calculate depreciation, you must know:
- The cost basis of the asset
- Its salvage value (lvalue at the end of its useful productive life)
- The estimated useful productive life
The simplest (non-accelerated) calculation method is straight-line, an equal amount over each year of useful life. The two common ways to calculate accelerated depreciation are to accelerate the depreciation by 150% or by 200%. Under the 150% method, an asset costing $10,000 with a useful life of 10 years would be fully depreciated in 6.67 years. Under the 200% method, it would be fully depreciated in 5 years.
What law allows for acceleration of depreciation?
Depreciation is part of the U.S. Tax Code, and Congress addressed the concept of accelerated depreciation several times. A system for calculating accelerated depreciation (called MACRS) was adopted as part of the Tax Reform Act of 1986. The 2017 Tax Cuts and Jobs Act is the most recent tax law dealing with accelerated deprecation, including section 179 deductions and bonus depreciation. One important feature of this legislation is that section 179 deductions are now permanent.
Why would you use accelerated depreciation?
Accelerating depreciation allows a business to write off the total cost of an asset over a faster time period than non-accelerated depreciation. Taking additional depreciation in a tax year means more expenses, which means a lower tax bill. The large tax deduction for the year can mean more money is available to your business to spend on more assets or use in some other productive way.