Bonus Depreciation and How It Affects Business Taxes

Business Owner figuring their Self-employment Tax due
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Bonus depreciation is a valuable tax-saving tool for businesses. It allows your business to take an immediate first-year deduction on the purchase of eligible business property, in addition to other depreciation. 

There are some restrictions on the type of property that can be depreciated using bonus depreciation. These restrictions are meant to make sure that the property was bought from an external unrelated source.

What is Depreciation?

Depreciation allows (or requires) businesses to spread out the cost of long-term assets over the life of the asset. The alternative would be to take the cost of the asset in the first year after the asset is acquired by the business, but this. Hence, accelerated depreciation, including bonus depreciation.

The most common way to depreciate a business asset is by spreading out the cost evenly over the asset life - called straight-line depreciation. 

But, Congress has frequently given additional incentives to businesses over the past few years, to encourage them to purchase capital assets for their businesses. One such encouragement is bonus depreciation. 

What is Bonus Depreciation?

Bonus depreciation is a method of accelerated depreciation that allows a business to make an additional deduction of 100% of the cost of qualifying property in the first ear in which it is put into service. This special deduction allowance is an additional deduction you can take after you take any Section 179 deduction and before you figure regular depreciation for the year. Bonus depreciation is for new or new-to-you equipment.

The IRS often calls bonus depreciation a "special depreciation allowance." 

In December 2017, Congress passed the Tax Cuts and Jobs Act (TCJA) that included some changes to increase the possibility that you can take bonus depreciation. Here are the details of the new provisions: 

  • Bonus depreciation doesn't have to be used for new purchases but must be "first use" by the business that buys it.
  • You can take bonus depreciation on machinery, equipment, computers, appliances, and furniture.
  • Bonus depreciation increased to 100% for qualified purchases made after September 17, 2017, and remains at 100% until January 1, 2023. 

This means you don't have to buy new property to get this deduction, as long as this is the first time you have placed it in service (bought and readied it for use).

Electing Out of Bonus Depreciation

Your tax professional may advise you not to take the bonus depreciation allowance for any class of property. To make this election, you'll need to attach a statement to your tax return. For example, if you want to elect out of taking bonus depreciation for vehicles, you can do that. The election must be made separately by each owner (as in a partnership or S corporation)

How Bonus Depreciation Works

First, you make the purchase of qualified business property. The property can be just about any kind except for land and buildings. Then you put the property in service, by setting it up and using it. Let's say the property is worth $1,000,000. First, you may be able to take a Section 179 deduction, to reduce the purchase price. Then you may be able to take the additional bonus depreciation of 100% of the remaining basis. The balance of the purchase is then depreciated in the usual way over a number of years. You can read more about how to calculate depreciation.

Qualifications and Restrictions

To be qualified to use bonus depreciation, it must be first used in the year you are claiming the first depreciation deduction. Only certain types of property may be eligible for bonus depreciation:

  • Property your business owns
  • Used in your business or income-producing activity
  • With a determinable useful life (based on IRS schedules for types of property
  • That is expected to last more than a year.

Some property is specifically excluded from being eligible for this deduction, including equipment used to build capital improvements, certain intangible property, and property disposed of in the year it was purchased.

Certain kinds of property, called listed property, must be used 50% or more for business use, to qualify for bonus depreciation. Listed property includes autos and other property that can be used for both business and personal purposes. (Computers are no longer considered listed property.)

If you use the Section 179 expense deduction, you must reduce the amount for calculating the bonus depreciation deduction.

Recording on Your Business Tax Return

Use IRS Form 4562 to record bonus depreciation and other types of depreciation and amortization. You might want to review the Instructions for Form 4562 before you begin this calculation. 

Getting Help

Depreciation is a complicated business process, and the laws regarding depreciation, particularly bonus depreciation and Section 179 deductions, are always changing. Before you make a business decision to buy a new property and claim a bonus depreciation expense, talk to your tax professional.