If you own a business, you know that purchasing equipment and assets for your company is a large investment. The costs can add up quickly, so you never want to miss an opportunity to save money by writing off those business expenses. Bonus depreciation can offset the costs of qualifying purchases of business assets by allowing you to deduct the purchases on your taxes in an accelerated manner. In other words, rather than depreciating your assets little by little over time, you may be able to take a large deduction right away.
What is bonus depreciation?
Depreciation is the process of deducting the cost of a business asset over time. Most business assets decrease in value as they slowly break down from use. Depreciation is designed to reduce your business's tax liability by tracking the decrease in value of your assets over time and allowing you to write off that decrease.
Bonus depreciation is a form of depreciation. However, it enables you to deduct a large percentage of the cost of your purchased business assets in the first year of their use rather than over time. This acts as a tax incentive for businesses to purchase qualifying assets.
Instead of gradually writing off the purchase cost of an asset, you can take a large deduction almost immediately. For a short time, you can take the total cost of the asset as a first-year bonus depreciation deduction, as the bonus depreciation rate is temporarily set at 100%.
Bonus depreciation and the Tax Cuts and Jobs Act
Bonus depreciation was temporarily expanded by the Tax Cuts and Jobs Act in 2017. The most notable expansion was increasing the bonus depreciation deduction from 50% of the asset purchase price to 100%. This was intended to reduce tax rates and encourage businesses to make qualifying purchases for their operations and growth.
The act also expanded bonus depreciation to apply to some purchases of used property. Prior to the Tax Cuts and Jobs Act, only new property qualified for bonus depreciation.
The bonus depreciation rate will remain at 100% through the end of 2022. It will then decrease by 20% each year.
Bonus depreciation vs. Section 179
Bonus depreciation is often confused with Section 179 deductions. This is understandable, as the two do serve similar purposes. However, there are some key differences between them.
Both bonus depreciation and Section 179 can be used to write off the cost of certain business assets. Currently, both deductions can be used to write off the total cost of an asset purchase in the first year of the asset's use.
One significant difference is that you may claim Section 179 only if your business has a taxable profit for the year. Bonus depreciation does not require your business to report a profit.
You can take both Section 179 and bonus depreciation deductions as long as your business has a taxable profit. For example, if your business invests $20,000 in new machinery but only reports a $10,000 profit at the end of the year, you may take $10,000 in Section 179 deductions, with the remaining $10,000 in bonus depreciation deductions. The two can be combined as long as Section 179 is applied before bonus depreciation deductions.
How does bonus depreciation work?
You'll need to follow these steps to take advantage of bonus depreciation.
1. Purchase a qualifying business asset.
The first step is to purchase an eligible business asset. After all, you can't depreciate something you haven't bought yet. An asset in business accounting is a property or resource owned by your business that you can use to generate cash flow. However, not all business assets qualify for bonus depreciation.
The IRS has specific guidelines on which assets qualify for bonus depreciation. Bonus depreciation may apply to the following assets:
- Property such as machinery, equipment, furniture, company vehicles and fixtures with a useful life of 20 years or less
- Depreciable computer software
- Water utility property
- Qualified leasehold improvement property, including improvements to the interior of commercial properties (for example, if you own a retail store and you put in new shelves and painted the interior of the store)
- Listed property that is used for business more than 50% of the time (such as vehicles and cameras used for both personal and professional purposes)
Property that will be disposed of in the same year it was placed in service (short-term-use property) does not qualify for bonus depreciation.
2. Use the purchased asset for business purposes.
A purchased asset qualifies for bonus depreciation for the year it was placed in service, rather than the year it was purchased. Placing the property in service means you have started using the asset for your business. For example, if you bought something in December 2021 but did not start using it for your business until January 2022, it would qualify for bonus depreciation in 2022.
The IRS considers an asset placed into service when it is "first placed in a condition or state of readiness and availability for a specifically assigned function." This means that if you purchase a piece of machinery, it should be fully set up and ready to use in order to count as being placed in service. It cannot be sitting in the corner of your warehouse unassembled or not immediately ready for use if needed.
3. Calculate the bonus depreciation amount.
The bonus depreciation amount is calculated based on the set bonus depreciation rate for the year. For 2022, calculations will be easy, as the bonus depreciation rate is 100%.
4. Report bonus depreciation on Form 4562.
You must report bonus depreciation on IRS Form 4562. The total amount of bonus depreciation you are claiming goes on line 14 of the form. If you are reporting bonus depreciation for multiple asset purchases, you should add up the bonus depreciation amounts for all qualifying asset purchases and report the sum on line 14.
5. File your business tax return.
You can now file your tax return for your business. Be sure to keep accurate records of all purchases, income and expenses to prepare for tax season. You are best served by using top-rated accounting software to do this.
How is bonus depreciation calculated?
Bonus depreciation is calculated by multiplying the cost of the qualifying asset by the appropriate bonus depreciation rate. See the chart below for the bonus depreciation rates for the next five years.
|Year asset is placed in service||Bonus depreciation rate|
For example, if you spend $10,000 on a new piece of equipment in 2022, the bonus depreciation amount will be the full $10,000. However, if you buy that same piece of $10,000 equipment in 2023, the bonus depreciation will be calculated at $8,000 (10,000 times 0.8).
Do you have to take bonus depreciation?
Bonus depreciation is fully optional; you don't have to take it. However, you may miss out on some great tax savings.
It is important to decide in a timely manner whether you will take bonus depreciation, as you may apply bonus depreciation only during the first year the asset is placed in service. You cannot decline bonus depreciation for purchased equipment and change your mind the following year.
However, choosing not to take bonus depreciation does not mean skipping depreciation altogether. Businesses that choose not to take bonus depreciation should still depreciate their assets over time using a standard depreciation model.