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What Is Bonus Depreciation?
Bonus depreciation is a tax break that allows businesses to immediately deduct a large percentage of the purchase price of eligible assets.
Bonus depreciation differs from traditional depreciation, in which the deduction would be spread over the asset’s useful life.
Bonus depreciation encourages business investment by offering immediate tax incentives.
The Tax Cuts and Jobs Act of 2017 increased bonus depreciation deductions from 50% to 100% for qualifying assets. But this increase is temporary, with its phaseout set for the end of 2027.
Bonus depreciation is claimed by filing Internal Revenue Service (IRS) Form 4562.
Key Takeaways
- Bonus depreciation allows businesses to immediately deduct a significant portion of the cost of eligible assets, unlike traditional depreciation methods that spread the deduction over the asset’s useful life.
- The Tax Cuts and Jobs Act of 2017 temporarily increased bonus depreciation deductions to 100% for qualifying assets, but is set to phase out by the end of 2027.
- Not all assets are eligible for bonus depreciation. Specific conditions must be met, such as a maximum 20-year useful life for tangible property and restrictions concerning prior use or acquisition from related parties.
- Unlike Section 179, bonus depreciation is not capped by dollar amount and can potentially exceed a business’s total income, allowing for substantial tax benefits in the year an asset is placed into service.
- Businesses should evaluate their unique tax situations when considering opting out of bonus depreciation, as doing so can impact future tax liabilities and may involve complex considerations best discussed with a tax advisor.
Understanding Bonus Depreciation Tax Benefits and Phaseout
Bonus depreciation is a tax break that lets businesses deduct costs quickly rather than spread them out over an asset’s life. It aims to spur business investment by offering immediate tax incentives. Depreciation helps reduce a company’s net earnings and tax liability. With bonus depreciation, companies get a big tax break in the year they buy the asset.
The Tax Cuts and Jobs Act of 2017 increased bonus depreciation from 50% to an initial 100% for qualified property. It also allowed used property to qualify under certain conditions. Bonus depreciation rates depend on when the property was put into use and are set to phase out by 2027.
| Bonus Depreciation Phaseout Schedule | |
|---|---|
| Year the Asset was Placed in Service | Bonus Depreciation Rate |
| 2022 | 100% |
| 2023 | 80% |
| 2024 | 60% |
| 2025 | 40% |
| 2026 | 20% |
| 2027 | 0% |
Important
Bonus depreciation rules can be complex and are subject to change, so it’s useful to consult a tax advisor who specializes in them.
The Evolution of Bonus Depreciation
Bonus depreciation began in 2002, but has changed over the years as the law has been updated.
| Bonus Depreciation, A Brief History | |
|---|---|
| Legislation | Notes |
| Job Creation and Worker Assistance Act (2002) | • Introduced bonus depreciation • Let companies deduct 30% of the cost of eligible assets before the standard depreciation method was applied |
| Jobs and Growth Tax Relief Reconciliation Act (2003) | • Increased the bonus depreciation rate to 50% |
| Economic Stimulus Act (2008) | • Maintained the bonus depreciation rate at 50% and extended the program |
| Protecting Americans from Tax Hikes (2015) | • Extended the program through 2019 • Included a phaseout of the bonus depreciation rate after 2017 |
| Tax Cuts and Jobs Act (2017) | • Raised the initial bonus depreciation rate to 100% • Extended the program through 2026 |
Assets That Qualify for Bonus Depreciation
Only certain business assets qualify for bonus depreciation. For example, tangible property must last 20 years or less. Under the Tax Cuts and Jobs Act, eligibility requirements also stipulated that:
- The asset cannot be used by the taxpayer before acquisition.
- The asset cannot be acquired by a related party to the taxpayer.
- The asset was not owned by a component member of a controlled group of corporations.
- The asset’s basis is not figured to the adjusted basis of the property when under the ownership of the seller.
- The asset’s basis is not figured to a basis acquired from a decedent.
Assets Ineligible for Bonus Depreciation
The rules disqualify certain assets from bonus depreciation:
- Primarily used in the trade of furnishing or sale of electrical energy, water, or sewage disposal services
- Primarily used in the trade of furnishing or the sale of gas or steam through distributed systems
- Primarily used in the trade of furnishing or the sale of gas or steam by pipeline
- Used in a trade or business that has had floor-plan financing indebtedness under certain circumstances
- Qualified improvement property such as leasehold improvements acquired after Dec. 31, 2017
How to Use IRS Form 4562 for Bonus Depreciation
Bonus depreciation is documented on federal tax returns using IRS Form 4562. This form also reports other depreciation types, like the Section 179 deduction.
To figure the depreciable base of the asset, the business should subtract any credits or deductions allocated to the property from the basis of the asset. Special treatment exists for assets acquired in a like-kind exchange or involuntary conversion.
A business may decide it would be more advantageous to recognize depreciation over the life of the asset instead of using an accelerated method and can elect not to take it. To make this election, they must attach a statement to their tax return indicating which class of property they wish to exclude. Once the election has been made, the decision cannot be revoked without IRS consent.
Fast Fact
If a business sells property that it claimed a special depreciation deduction for, it is often required to recognize any recaptured amount as ordinary income.
Comparing Bonus Depreciation and Section 179 Deductions
Section 179 allows businesses to claim a larger depreciation deduction for qualifying property for the tax year the asset was put into service. Section 179 rules are more flexible in terms of timing than bonus depreciation rules. A business can elect to save certain assets for future tax breaks or claim only a portion of the cost and defer the other portion for a future tax year.
Bonus depreciation allows defined deductions without dollar caps, so a large deduction can be claimed for one asset in a single year. Section 179 deductions are limited by law.
As the IRS explains, “For tax years beginning in 2023, the maximum section 179 expense deduction is $1,160,000. This limit is reduced by the amount by which the cost of section 179 property placed in service during the tax year exceeds $2,890,000.” The IRS notes, “The maximum section 179 expense deduction for sport utility vehicles (SUVs) placed in service in tax years beginning in 2023 is $28,900.”
Tip
Section 179 deductions are limited to annual business income, while bonus depreciation can exceed that amount. It is also possible to claim both bonus depreciation and Section 179 deductions in the same tax year.
Do Vehicles Qualify for Bonus Depreciation?
Yes, vehicles are eligible for bonus depreciation, although the amount is limited. For tax year 2025, that limit is $20,200.
Why Would a Business Opt Out of Bonus Depreciation?
Electing to take bonus depreciation is often favorable for businesses seeking to minimize their short-term tax liabilities. Though future-year liabilities may be higher due to having a lower amount of depreciation to claim, this may also create a net business loss that can be rolled over and carried to future years. There may also be situations where it makes more sense to elect out.
What Assets Qualify for Bonus Depreciation?
The IRS defines “qualifying property” for bonus depreciation purposes as (1) tangible property depreciated under the modified accelerated cost recovery system (MACRS) with a useful life of 20 years or less, (2) certain computer software, (3) water utility property, and (4) qualifying film, television, or live theatrical productions.
The Bottom Line
Bonus depreciation is a tax break for businesses buying new assets. It allows businesses to deduct a large percentage of the cost of eligible purchases in the year when they acquire them.
Bonus depreciation aims to encourage business investment by offering significant and immediate tax benefits.
The bonus depreciation deduction doubled to 100% under the Tax Cuts and Jobs Act of 2017, but its current status is scheduled to be phased out by the end of 2027.
Bonus depreciation is similar to Section 179 deductions but sometimes has higher dollar limits. They also differ in that Section 179:
- Allows businesses to claim a larger depreciation deduction for qualifying property in the tax year when the asset went into service
- Is more flexible in timing, letting a business save certain assets for future tax breaks or claim only a portion of the cost and defer the rest for a future tax year
Businesses may choose to opt out of bonus depreciation, but this option can affect future tax liabilities. They must attach a special election statement to IRS Form 4562 that says they are opting out.
Businesses trying to navigate the complexity of bonus depreciation rules should consult a tax advisor.
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