What you need to know about bonus depreciation

bonus depreciation

Real estate property. Heavy machinery. Top-of-the-line computers and software. What do these items all have in common? If you buy them for your business, you may be able to make use of the bonus depreciation tax incentive. 

Bonus depreciation is a popular tax incentive that lets your business immediately deduct a significant portion of the purchase price of eligible assets instead of writing them off over the course of their “useful life.” While this is a useful tax benefit, though, there are nuances that business owners need to be aware of. 

Upcoming changes to laws

Current tax policy is gearing up to eliminate bonus depreciation starting in 2023. The 100% bonus depreciation for property placed in service between 2023 and 2027 will be gradually phased out in the following increments.

  • Property placed in service in 2023: 80%
  • Property placed in service in 2024: 60%
  • Property placed in service in 2025: 40%
  • Property placed in service in 2026: 20%
  • Property placed in service in 2027 and later: 0%

For aircraft and other property with a lengthy production process, the phaseouts will take place between 2024-2008.

Note that while this is currently scheduled, it’s entirely possible that legislation might be passed to revise the rules 

Rules apply to your new and most used property

Previous policies excluded used property, but as of now, it can qualify for bonus depreciation unless:  

  • It was previously used by the taxpayer
  • It was acquired in the course of prohibited transactions, most commonly tax-free acquisitions or from a related individual or entity.  

Bonus depreciation isn’t always the best move

You don’t have to make use of bonus depreciations. For sole proprietors, partnerships, and S corporations, electing out of bonus depreciation allows them to apply depreciation deductions more strategically; they can apply them against lower-bracket income for the year they were placed in service rather than a higher bracket income in coming years. 

Remember, business entities that are taxed as “regular” corporations are taxed at a flat rate, unlike S corporations.

Building improvements can qualify

As a result of the Tax Cuts and Jobs Act (TCJA) of 2017, you can apply bonus depreciation for two types of real property:

  • Non-building land improvements such as fencing or parking lots
  • “Qualified improvement property,” which is a broad category of internal improvements to non-residential buildings after the buildings are placed in service.

The TCJA inadvertently removed bonus depreciation for qualified improvement property, but the 2020 Coronavirus Aid, Relief and Economic Security Act (CARES Act) retroactively corrected the issue. This correction allows qualified improvement property placed in service after December 31, 2017 to be used for bonus depreciation.

Section 179 expensing is less important now  

Smaller businesses often benefit from Section 179 expensing, a limited elective benefit that lets businesses immediately deduct the cost of purchases like equipment, machinery, off-the-shelf computer software and some building improvements. TCJA enhanced Section 179, but the 100% bonus depreciation is an economic equivalent and makes Section 179 less useful for businesses.

We’re here to help

Bonus depreciation is an important resource for businesses, but the tax implications are complex. If you have questions about how you can apply this deduction to your tax return next year, contact Smolin Lupin and learn more.