BONUS DEPRECIATION PHASE OUT
What is bonus depreciation?
Bonus depreciation is a business tax incentive that was first enacted by Congress’ Job Creation and Worker Assistance Act of 2002 as a temporary deduction to encourage businesses to invest and, in turn, stimulate the economy following the 9/11 terrorist attacks.
Bonus depreciation accelerates depreciation by allowing businesses to write off a large percentage of the eligible asset's cost in the first year it was purchased. The remaining cost can be deducted over multiple years using regular depreciation until it phases out.
The passage of the Tax Cuts and Jobs Act (TCJA) in 2017 made major changes to the rules. Most significantly, it enacted 100% bonus depreciation, allowing businesses to immediately write off 100% of the cost of eligible property acquired and placed in service after Sept. 27, 2017, and before Jan. 1, 2023. Prior to TCJA, it was 50%.
The 100% write-off of eligible property expired Dec. 31, 2022. Unless the law changes, the bonus percentage will decrease by 20 points each year for property placed in service after Dec. 31, 2022, and before Jan. 1, 2027.
The phase-out schedule is:
2022: 100%
2023: 80%
2024: 60%
2025: 40%
2026: 20%
2027: 0%
How does bonus depreciation work?
Bonus depreciation works by first purchasing qualified business property and then putting that asset into service prior to year-end.
Bonus depreciation is then reported to the IRS.
For example, if a business purchased new computer software in December 2022, but didn’t put that software into service until January 2023, the business would then be required to wait until it filed its 2023 tax return to claim bonus depreciation on the software. Since the bonus depreciation phase out begins January 2023, the business would then be eligible for 80% bonus depreciation (not 100%).
What are the tax benefits of bonus depreciation?
Bonus depreciation is an important tax savings tools for businesses as it allows them to take an immediate deduction in the first year on the cost of eligible business property. This lowers a company’s tax liability because it reduces their taxable income.
What qualifies for bonus depreciation?
In order to qualify for bonus depreciation deduction, certain criteria must be met. Qualifying assets can include:
Modified Accelerated Cost Recovery System (MACRS) property with a recovery period of 20 years or less. This includes such property as computer equipment and office furniture.
Depreciable computer software.
Water utility property.
Qualified leasehold improvement property like any improvement to the interior portion of a nonresidential building. The improvement must be placed in service more than three years after the date the building was first placed in service.
Costs of certain film, television, and live theatrical productions.
Vacation property if a taxpayer is using the vacation property as a short-term rental (i.e., Airbnb, etc.). The passage of the TCJA created the property class known as Qualified Leasehold Improvement Property. If the short-term rental is a commercial property, and the taxpayer improves the interior of the building, it may qualify for bonus depreciation.
Residential rental estate if the taxpayer conducts a cost segregation study.
Vehicles which have a useful life of 20 years or less.
Used equipment if it was not used by the taxpayer at any time prior to the acquisition.
Additional information about eligibility requirements can be found at Proposed Treas. Reg. § 1.168(k)-2(b)) and on the IRS’ FAQ page.
What is the difference between bonus depreciation and section 179?
While bonus depreciation and Section 179 are both immediate expense deductions, bonus depreciation allows taxpayers to deduct a percentage of an asset’s cost upfront; whereas, Section 179 allows taxpayers to deduct a set dollar amount. There are additional notable differences.
Section 179 has a limit on the annual deduction. In 2022, the maximum section 179 expense deduction was $1,080,000. To take the full deduction, the purchase price of the eligible property cannot exceed $2,700,000. Bonus depreciation has no annual limit on the deduction.
Section 179 deductions are also limited to annual taxable business income, meaning that a business cannot deduct more money than it made. Bonus depreciation does not have this limit and can be used to create a net loss.
Businesses may be able to combine bonus depreciation and section 179 deductions to claim both deductions in the same tax year. As bonus depreciation phases out in the coming years, some taxpayers may be able to maintain some initial-year expensing through section 179 rules.
How do you calculate bonus depreciation?
To calculate the bonus depreciation, you need to multiply the bonus depreciation rate (which is prevailing in the market) with the cost of the business asset. Then deduct the tax of the property from the cost of the asset.
For example:
Amount of bonus depreciation: Cost of asset $1,000,000 X 21% tax rate = $210,000 bonus depreciation can be claimed
Cost of asset $1,000,000 - $210,000 bonus depreciation = $790,000 depreciated value of the asset
How do you report bonus depreciation?
To report a bonus depreciation, the election must be made by filing a statement with IRS Form 4562, “Depreciation and Amortization,” by the due date (including extensions) of the Federal tax return for the taxable year in which the qualified property is placed in service by the taxpayer.
Can bonus depreciation create a loss?
Yes, bonus depreciation can be used to create a net loss. If the bonus depreciation deduction creates a net operating loss for the year, the company can carry forward the net operating loss to offset future income.
Is bonus depreciation subject to recapture?
Yes, when property, for which bonus depreciation was claimed, is sold that depreciation is recaptured and taxed as regular income. However, there’s a cap on the tax rate of 25%.
When does bonus depreciation expire?
Unless the law changes, the bonus percentage will decrease by 20 points each year over the next several years until it phases out completely for property placed in service after Dec. 31, 2026. Bonus depreciation will be 0% for property placed in service Jan. 1, 2027 and later.
Which states allow bonus depreciation?
The state tax treatment of bonus depreciation provisions depend on the state’s conformity to the Internal Revenue Code (IRC) and each state’s decoupling provisions. States follow different approaches in adopting conformity to the IRC, resulting in inconsistent state tax treatment of federal expensing and bonus depreciation rules. Some states conform to the current IRC (e.g., Colorado, Kansas, Louisiana), other states have decoupled from the IRC provisions (e.g., Illinois, New Jersey, New York, Pennsylvania), and others have enacted legislation that allows partial conformity or conformity in some but not all tax years covered by the federal rule (e.g., Arkansas, Connecticut, Kentucky).