What is Bonus Depreciation?

Bonus depreciation is a tax incentive that allows a business to immediately deduct a large percentage of the purchase price of eligible assets, such as machinery, rather than write them off over the "useful life" of that asset. Bonus depreciation is also known as the additional first year depreciation deduction.

How Bonus Depreciation Works

When a business makes an acquisition, such as machinery, the cost, for tax accounting purposes, has traditionally been spread out over the useful life of that asset. This process is known as depreciation and can sometimes work in a company’s favor. If depreciation is not applied, a company’s financial statement could take a severe hit, showing smaller profits or larger losses for the year it made the acquisition.

The Tax Cuts and Jobs Act of 2017 doubled the bonus depreciation deduction from 50% to 100%.

The Tax Cuts and Jobs Act, passed in 2017, made major changes to the rules on bonus depreciation. Most significantly, it doubled the bonus depreciation deduction for qualified property, as defined by the IRS, from 50% to 100%. The 2017 law also extended the bonus to cover used property under certain conditions. Formerly it applied only to property bought new.

The new bonus depreciation rules apply to property acquired and placed in service after September 27, 2017, and before January 1, 2023, at which time the provision expires unless Congress renews it. In 2023, the rate for bonus depreciation will be 80%. In 2024, it will be 60%, and in 2025, it will be 40%. In 2026, it will be 20% (assuming Congress doesn't change the law before then). Property acquired before September 27, 2017, remains subject to the prior rules. Bonus depreciation is calculated by multiplying the bonus depreciation rate (currently 100%) by the cost basis of the acquired asset. For a business that claims bonus depreciation on an item that costs $100,000, for example, the resulting deduction would be worth $21,000, assuming the company's tax rate is 21%.

Bonus depreciation must be taken in the first year that the depreciable item is placed in service. However, businesses can elect not to use bonus depreciation and instead depreciate the property over a longer period if they find that advantageous.

Key Takeaways

  • Bonus depreciation allows businesses to deduct a large percentage of the cost of eligible purchases the year they acquire them, rather than depreciating them over a period of years.
  • It was created as a way to encourage investment by small businesses and stimulate the economy.
  • Businesses should use IRS Form 4562 to record bonus depreciation as well as other types of depreciation and amortization.
  • The rules and limits for bonus depreciation have changed over the years, and the latest ones are scheduled to expire in 2023.

History of Bonus Depreciation

Congress introduced bonus depreciation in 2002 through the Job Creation and Worker Assistance Act. Its purpose was to allow businesses to recover the cost of capital acquisitions more quickly in order to stimulate the economy. The bonus depreciation lets companies deduct 30% of the cost of eligible assets before the standard depreciation method was applied. To be eligible for bonus depreciation, assets had to be purchased between September 10, 2001, and September 11, 2004.

The 2003 Jobs and Growth Tax Relief Reconciliation Act (JGTRRA) increased the bonus depreciation rate to 50% for property originally used after May 3, 2003, and placed in service before January 1, 2005. Placing an asset in service means that it is actively used in the operations of a business. The 50% depreciation incentive was introduced again through the 2008 Economic Stimulus Act for property acquired after December 31, 2007.

The 2015 Protecting Americans from Tax Hikes (PATH) Act extended this program through 2019 for business owners but included a phase-out of the bonus depreciation rate after 2017. Under PATH, businesses were allowed to deduct their capital expenses by 50% for 2015, 2016, and 2017. The rate was then scheduled to drop to 40% in 2018 and 30% in 2019.

In 2017 the Tax Cuts and Jobs Act raised the rate to 100% and made other changes to the law, as described above.