Bonus depreciation: Finding flexibility in deducting business costs
4 min read
March 29, 2021 • Block Advisors
You may know that depreciation lets you spread out the cost of certain fixed assets over time. But, what about bonus depreciation? This alternative method gives you additional flexibility in deducting those costs — which may work out better for your business—depending on your circumstances. Interested in learning more? Read on!
What is bonus depreciation?
First order of business is answering, “What is bonus depreciation?”
Long story short, regular depreciation allows your business to write off the cost of a tangible asset over its life, which is the number of years the asset will be used. It is an expense that can offset income to immediately lower the tax due on income. The government knows businesses can stimulate the economy by buying things, so this provides an incentive for small businesses to do so.
Essentially, bonus depreciation allows your business to take an immediate first-year deduction on the purchase of eligible business property, in addition to the asset’s regular depreciation schedule. It is a quicker depreciation schedule for a more immediate expense deduction. You will report bonus depreciation on Form 4562.
In other words, it’s a method of accelerated depreciation, so businesses can deduct the cost of qualifying property in the year in which it is put into service.
Bonus depreciation and tax reform
The Tax Cut and Jobs Act (TCJA) included a provision for bonus depreciation that allows a deduction for 100% of the purchase price of qualifying property. Previously, the deduction was 50%.
This provision applies to qualifying property acquired and placed in service after September 27, 2017, and before January 1, 2023—unless Congress renews it.
After January 1, 2023, the rates will step down each year:
- 2023: 80%
- 2024: 60%
- 2025: 40%
- 2026: 20%
What qualifies for bonus depreciation?
Wondering what qualifies for bonus depreciation? Not all property qualifies for the 100% bonus depreciation deduction.
Several reviews must be met for listed property to qualify:
- The property must have a MACRS recovery period of 20 years or fewer (property other than building structures or building systems).
- The property can’t be excluded from bonus depreciation.
- It’s only allowed for the year the property is placed in service.
- Even if property qualifies for bonus depreciation, you can elect out of this provision and use the applicable MACRS depreciation method instead.
Also, vehicles have different limits, depending on its type and size. For example, vehicles with a gross vehicle weight of 6,000 pounds or less are limited to $8,000 of first-year bonus depreciation. The remaining cost is depreciated under special rules, found in IRS publication 946. Combined first-year depreciation (bonus plus regular) is limited to $18,000 for passenger cars (other than heavy SUVs), trucks, and vans.
This IRS table highlights vehicle depreciation limits.
Don’t want to tackle the tax nuances of bonus depreciation alone? Get help with your small business taxes from the team at Block Advisors.
Which is better? Bonus depreciation or Section 179?
Bonus depreciation and Section 179 both allow an immediate deduction, but they do it in different ways.
Bonus depreciation has a couple of advantages:
- It creates a net operating loss (NOL) whereas Section 179 is limited to taxable income.
- If the business use percentage of a property falls below 50%, deductions claimed under Section 179 must be recaptured (more on that below) as ordinary income, whereas those claimed as bonus depreciation don’t have to be recaptured until the property is sold.
Note: Some property qualifies for 100% expensing under both Section 179 and bonus depreciation. For more information on Section 179 deductions for vehicles, read on!
State tax treatment of bonus depreciation
Another important consideration is your state income tax treatment of the depreciable property. It’s common for states to require a smaller depreciation deduction even though you qualify for 100% bonus depreciation or Section 179 expensing on your federal tax return. So, if you decide to use 100% bonus depreciation on your federal return, you may have to keep a separate depreciation schedule for state income tax purposes.
What about bonus depreciation recapture?
Wondering who qualifies for bonus depreciation recapture? Any business entity qualifies for bonus depreciation recapture.
Get help with bonus depreciation on qualified property
All these considerations require a careful analysis of your particular financial and tax situation. At Block Advisors, we have the expertise and experience to help you make the decision that’s best for you. Get back to the tasks you enjoy and let us handle your business’ taxes, bookkeeping, and payroll.