How Much Can I Deduct for Bonus Depreciation?

As a small business owner, you want to take advantage of every available opportunity to maximize your profit and minimize your taxes. One such opportunity is bonus depreciation. But what exactly is the bonus depreciation deduction?

It's easy to get caught up in the details, so we'll break down all you need to know: what it is, when and how much you can deduct, and what types of property qualify. 

Don't worry—understanding this beneficial deduction doesn't have to be difficult! We'll provide an overview that will help make everything clear.

What is Bonus Depreciation?

Bonus depreciation is a tax incentive that allows businesses to deduct a large percentage of a new piece of equipment, machinery or technology the year it's first used rather than depreciating it over several years. 

This allows businesses to claim the larger deduction immediately and essentially save a lump sum on taxes.

It's designed to give businesses an incentive to invest in new capital assets (which is good for the economy) while simultaneously providing them with more cash flow. They can then use that to grow their business.

When Can You Claim It?

Bonus depreciation is available in the year the asset is placed in service. That may differ from the year it was purchased. 

For example, if you buy a piece of equipment in December 2023 but don't start using it for your business until January 2024, you would have to wait to claim bonus depreciation on the equipment until you file your 2024 tax return.

How Much Can You Deduct? 

For equipment put into use in 2023, you can deduct 80% of its cost from your 2024 taxes. 

This is different than in years past. In fact, from September 28, 2017, through December 31, 2022, businesses could deduct 100% of the cost of qualifying property under these rules. 

However, that percentage is scheduled to slowly phase out, dropping by 20% each year until bonus depreciation is eliminated in 2027.

So, unless Congress acts to change or extend this section of the tax code, the available percentages are:

• 80% in 2023
• 60% in 2024
• 40% in 2025
• 20% in 2026
• 0% in 2027 and beyond

What Types of Property Qualify for Bonus Depreciation?

Bonus depreciation is available for many types of business assets. To qualify, your property must be tangible personal property with a depreciable life of 20 years or less. This can include:

• Machinery
• Vehicles
• Computer software
• Leasehold improvements
• Furniture

But it doesn't include land, buildings, or intangible assets, such as patents or trademarks.

In previous versions of IRS depreciation rules, used property didn't qualify for bonus depreciation. However, the Tax Cuts and Jobs Act (TCJA) of 2017 made it available for new and used property, as long as the property wasn't acquired from a related party. 

The related party eligibility restrictions are meant to prevent business owners from transferring property to a related company to claim the business tax write-off twice on the same asset.

Example of How Bonus Depreciation Works

Say you purchase a piece of equipment that costs $20,000 in January 2023 and place it in service right away.

Say you follow normal modified accelerated cost recovery system (MACRS) depreciation rules for this piece of equipment and depreciate it over seven years. Using a MACRS depreciation calculator, you discover your first-year depreciation deduction would only be about $5,476. 

However, if you took advantage of bonus depreciation, your write-off would be $16,000 in the first year (80% of $20,000). 

That would give you more than $10,000 in additional cash flow you could use to pay employees, pay down debt, reinvest in your business, or put to another purpose.

Pros and Cons of Bonus Depreciation

The advantages of bonus depreciation are clear: the tax savings allow your business to get more cash flow right away. This can help jump-start growth and make the most of the purchase by deducting a larger percentage of costs in the year you place the property in service. 

So, if you want to make some big investments ASAP, like in new team members, software or additional equipment, it could be really useful.

However, there are some reasons you should think twice before claiming accelerated depreciation. The downsides mostly relate to tax planning.

Claiming bonus depreciation doesn't actually give you a bigger write-off than claiming regular depreciation—it's just a matter of what year you take the tax deduction in. And there can be situations in which you want to save your tax deduction for later when you might be in a higher tax bracket.

For example, say you bought that $20,000 piece of equipment in 2023 but only have a little business income to offset in 2023. 

However, you know that next year you'll have a big contract come through and will have much more taxable income, pushing you into a higher tax bracket. 

In that case, it might make sense not to take bonus depreciation on the equipment so that you can claim a larger deduction next year. You'd have more write-offs in year two, thus less taxable income and a smaller tax bill.

What Happens if I Don't Take the Deduction?

Bonus is the default, so if you elect out of claiming the expense deduction on one category of assets, such as 7-year equipment, then you elect out of claiming it on all assets in that category.

For example, say you don't want to take bonus depreciation on the $20,000 piece of equipment. That equipment has a seven-year recovery period—the IRS's way of saying the number of years you'd normally depreciate it over. 

So you can't claim bonus depreciation on a different piece of equipment with a seven-year useful life. However, you could still claim this tax benefit for five-year property, such as a business vehicle.

To choose not to take it, you have to make an election on your federal income tax return. This simply involves attaching a statement to Form 4562—the form used to claim depreciation on your tax return.

Here's a sample election statement:

Election Out of the Special Depreciation Allowance (Bonus Depreciation)

Under IRC Section 168(k)(7)

Your Name and Social Security or Tax ID Number

‍

Your Address

‍

Tax Year Ending 20XX

Taxpayer elects under IRS Section 168(k)(7) to not claim the additional 80% first-year bonus depreciation deduction for [class of property] placed in service during the tax year ended 20XX.

If you have a professional prepare your tax return for you, they can usually check a box to attach that election statement to your return.

Are Bonus Depreciation and Section 179 the Same?

No. Bonus depreciation and Section 179 are similar in that they allow you to write off more of the cost of assets used in your business, but they're not the same.

Bonus depreciation allows businesses to immediately deduct up to 80% of the cost of qualifying property placed in service during the year.

Section 179 allows businesses to immediately deduct up to $1,160,000 of the cost of qualifying property acquired and placed in service during the tax year.

Unlike the Section 179 deduction, bonus depreciation is:

• Not limited to an annual dollar amount
• Not limited to your business's annual profits
• Not limited to property that is used 50% or more for business purposes

You may be able to claim both bonus depreciation and Section 179 in the same year as long as they're applied to different pieces of qualifying property.

Bonus Depreciation FAQs

Bonus depreciation is an important tax tool available to businesses that can help them save money on the purchase of qualifying property. To get the most out of this powerful deduction, we've compiled some frequently asked questions about bonus depreciation below.

Is Bonus Depreciation still 100%?

No, you can't deduct 100% of a qualifying asset that's placed in service in 2023 and beyond. For 2023, the bonus depreciation rate is 80%, and it will decrease by 20% each year until it reaches 0% in 2027. You used to be able to claim 100%—from 2017 through 2022, businesses could immediately deduct 100% of the cost of qualifying property. 

Does Bonus Depreciation Apply to Used Property?

Yes. Since 2017, businesses can use bonus depreciation for both new and used qualifying property. However, the property must not have been acquired from a related party to qualify.

Can Bonus Depreciation be Used for Real Estate?

No, bonus depreciation rules only apply to tangible property with a useful life of 20 years or less. This means you can't use it on real property, including land—which isn't depreciable at all—or buildings. For tax purposes, you can depreciate residential rental property over 27.5 years and commercial buildings over 30 years.

However, qualified improvement property does qualify for bonus depreciation. This includes interior, non-structural improvements to commercial buildings made after the building was originally placed in service.

So, if you are a real estate owner who renovated one of your existing buildings, you may want to have a cost segregation study done to determine if any of those improvements qualify for immediate write-off under bonus depreciation rules.

In a cost segregation study, a team of tax advisors and engineers look at all the components of a building, such as plumbing fixtures, carpeting, and sidewalks, and work together to decide which components can be depreciated on a faster timeline than the building itself.

Many CPA firms offer cost segregation studies, so check with your accountant to see if you could benefit.

Do States Allow Bonus Depreciation?

Some states allow bonus depreciation and some don't, so it's a good idea to check with your tax professional. 

Grow Your Business and Boost Cash Flow with Bonus Depreciation

Overall, bonus depreciation can be an excellent way to take advantage of tax savings that help you afford new equipment and other business needs. 

Still, it's a good idea to weigh the pros and cons carefully and consult a tax advisor before making any final decisions. With careful planning, you can maximize the benefits of this valuable incentive and get an immediate boost to your cash flow!