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. It’s also known as the additional first year depreciation deduction because it must be taken in the first year that the depreciable item is placed in service. It’s important to keep in mind that to be depreciable, property must have a “determinable useful life,” meaning that it must wear out and lose value over time. It must also last more than one year, so if it is put into use and disposed of in the same year, it is not considered depreciable.
Traditionally, when a business purchases equipment, the cost has been spread out over the useful life of that asset. This is known as depreciation. It can work in a business’s favor because if depreciation is not applied, it could negatively affect a business’s financial statement by showing smaller profits or larger losses for the year it purchased the equipment.
When the Tax Cuts and Jobs Act was passed in 2017, it made significant changes to how bonus depreciation affects businesses. The most major change was that it doubled the bonus depreciation deduction for qualified equipment from 50% to 100%. The Act also extended the bonus to cover used equipment, in addition to new equipment that was already covered previous to the passing of the Act.
Bonus depreciation following the passing of the tax law applies to equipment that has been acquired and put into service after September 27, 2017 and before January 1, 2023. Unless the law is renewed, the provision expires on January 1, 2023. That being said, equipment purchased before September 27, 2017 are subject to the prior rules.
In a previous blog post, we discussed the basics of the Section 179 Deduction. In short, businesses can deduct up to $1,000,000 of qualified equipment immediately, with a limit of $2,500,000, after which the deduction begins to phase out on a dollar-for-dollar basis. For this reason, bonus depreciation is useful to very large businesses spending more than the Section 179 spending cap of $2,500,000 on new capital equipment.
Bonus depreciation is often confused with Section 179 because they serve similar purposes. Section 179 is limited to a taxpayer’s business income. Passive income, such as assets used in rental property, is not eligible for the deduction. Both new and used equipment qualify for the Section 179 Deduction (as long as the used equipment is “new to you”), while bonus depreciation has only recently begun to cover both used and new equipment, after the previously mentioned tax law passed in 2017.
When applying these tax incentives, Section 179 is generally taken first, and then bonus depreciation. If a business is unprofitable, it is allowed to carry the loss forward into future years, since there is no taxable profit.
DISCLAIMER: Currency does not provide tax, legal or accounting advice. The foregoing has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any transaction.