Bonus Depreciation: What It Is and How It WorksBusiness Taxes
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Typically, the IRS requires taxpayers to depreciate assets over several years. This results in a relatively small percentage of the cost of an asset being allowed as a deduction each year.
For example, if you install a fence on your rental property, you would have to depreciate this asset over fifteen years using special formulas published by the IRS. Over the next 15 years, you will be able to deduct between 2.95% and 9.50% of the asset’s cost per year with the exact percentage depending on how many years have passed since you first placed the fence in service.
If you’re like most taxpayers, you would prefer to be able to deduct that entire cost today. And this is exactly what bonus depreciation can help you accomplish.
Bonus Depreciation Overview
The rules surrounding bonus depreciation are found in Section 168(k) of the Internal Revenue Code. But you don’t have to worry about that. Here’s a quick overview of bonus depreciation.
What Is Bonus Depreciation?
Bonus depreciation is a “special” depreciation allowance that currently permits you to deduct all or a percentage of the cost of an asset in the year you purchased it. This percentage depends on the date you place the asset in service.
Why Did Congress Create Bonus Depreciation?
Congress’ intent with bonus depreciation, of course, is to stimulate the economy. The exact percentage of an asset’s cost that may be written off in the first year has ranged from 30% to 100% since bonus depreciation was first created by the Job Creation and Worker Assistance Act of 2002 during the George W. Bush administration.
What Is the Current Bonus Depreciation Rate?
Most recently, the Tax Cuts and Jobs Act of 2017 set the bonus depreciation percentage to 100% for assets placed in service between September 28, 2017, and December 31, 2022.
This means that if you put bonus-eligible property into service between now and December 31, 2022, you can write off its entire cost in the year of purchase.
Apart from Congressional action, bonus depreciation will revert to lower levels. Below is a table showing the bonus depreciation levels as they currently exist.
|Assets Placed in Service Between||Bonus Depreciation Rate|
|September 28, 2017 - December 31, 2022||100%|
|January 1, 2023 - December 31, 2023||80%|
|January 1, 2024 - December 31, 2024||60%|
|January 1, 2025 - December 31, 2025||40%|
|January 1, 2026 - December 31, 2026||20%|
What Assets Qualify?
There are three kinds of assets that qualify for bonus depreciation:
- MACRS property with a recovery period of 20 years or less,
- depreciable computer software, and
- water utility property.
That first category — MACRS property with a recovery period of 20 years or less — is by far the most common type of asset eligible for bonus depreciation, so I’ll discuss this one first.
Assets With a Life of 20 Years or Less
MACRS stands for Modified Accelerated Cost Recovery System, which has been the depreciation system used for United States income tax purposes since the Tax Reform Act of 1986. It’s called “modified” because there was previously the “Accelerated Cost Recovery System” implemented in 1981.
Under MACRS, there are various asset classes, and each class has a “useful life” that represents the number of years over which the asset’s tax basis must be depreciated. There are actually two “sets” of MACRS asset classes, the General Depreciation System (GDS) and the Alternative Depreciation System (ADS), with the latter generally having a long useful life for a given asset class.
GDS is by far the most commonly used MACRS system. ADS must be used in certain circumstances (for example, for foreign assets), but since it’s used so rarely I will only discuss GDS class lives.
Below is a table summarizing the GDS useful lives for some of the most common assets. Property with a useful life of 20 years or less is eligible for bonus depreciation.
|Useful Life||Asset Type|
|5 Years||Automobiles, Computers, Information Systems|
|7 Years||Office Furniture, Fixtures, and Equipment; Any Property Not in Another Class|
|15 Years||Land Improvements|
|20 Years||Farm Buildings|
|27.5 Years||Residential Rental Property|
|39 Years||Commercial Rental Property|
Depreciable Computer Software
When it comes to depreciation, not all computer software is created equal.
Proprietary software that is developed by the taxpayer is not eligible for bonus depreciation.
Off-the-shelf software readily available for purchase by the general public, however, is eligible for bonus depreciation.
Water Utility Property
For these purposes, water utility property is essentially municipal sewers.
Bonus on Used Property
For most of its history, bonus depreciation has only been permitted on new — that is, never-before-owned — property. The Tax Cuts & Jobs Act of 2017, however, now permits bonus depreciation to be taken on used property as well. However, it must be new to you, that is, you may have never owned it before (but somebody else could have).
Electing Out of Bonus
Believe it or not, bonus depreciation is automatically applied on your tax return, and you have to attach a statement to your tax return informing the IRS that you would like to opt out of bonus depreciation for the year. You can elect to opt out of bonus depreciation for certain asset classes (see the discussion above), or you can elect to opt out of bonus depreciation for all asset classes.
Why Would You Want to Opt Out?
It sounds funny, doesn’t it? Why would anybody want to opt out of expensing the entire cost of an asset this year, preferring rather to deduct the cost over several years?
The most typical scenario is when a taxpayer is a in a lower tax bracket this year than he or she expect to be in future years.
Perhaps this year you are in the 24% tax bracket but you expect your income to be in the 35% tax bracket starting next year. In this case, it may make sense for you to opt out of bonus depreciation so you can take more expenses against your income when you are in a higher tax bracket.
Sample Bonus Opt-Out Election
Here is a sample bonus opt-out election:
Election to Not Claim Additional Depreciation
Pursuant to IRC Section 168(k)(7), the taxpayer hereby elects to not claim the additional depreciation allowance for all classes of property in the tax year ended December 31, 2019.
Bonus and Rental Property
Before the Tax Cuts & Jobs Act of 2017, bonus depreciation could be used to a limited degree by landlords on things like new appliances and land improvements.
Used Property Now Eligible
However, now that the Tax Cuts & Jobs Act permits bonus depreciation to be taken on used property as well as new property, more owners of rental property will be able to use bonus depreciation on used property as well.
So that used refrigerator you picked up to replace that old clunker in your rental unit? Yup, it’s now bonus eligible.
Cost Segregation Implications
The biggest boon for real estate investors, however, is that cost segregation studies are now much more valuable.
Don’t get me wrong — cost segregation studies were great before. They allowed building owners to segregate a portion of their building costs as repairs, 5-year property, 7-year property, or 15-year property, greatly accelerating the rate at which they could expense the cost of their building. Previously, however, 5-, 7-, and 15-year property in a cost segregation study was generally not eligible for bonus depreciation because the property was used at acquisition (i.e. it had been used by the previous building owner).
Now, however, all that 5-year, 7-year, and 15-year property is eligible to be deducted immediately under the bonus depreciation rules because the Tax Cuts and Jobs Act of 2017 made used assets likewise eligible for bonus depreciation.
Bonus and Vehicles
Yes, you can take bonus depreciation on vehicles. How much you can take, however, depends on the gross vehicle weight rating (GVWR), which is set by the manufacturer of the automobile. You can find a vehicle’s GVWR on the manufacturer’s website or on a sticker on the driver’s side door.
I get into the rules based on GVWR below, but remember that depreciation, including bonus depreciation, may only be taken on assets to the extent of its business use. So if you purchase an asset for $50,000, and you use it for business use 80% of the time, its tax basis is $40,000. This is the maximum depreciable amount.
And remember, as with any depreciation calculation, the key date is not when you purchased the vehicle; it’s when you placed it in service i.e. when you started using it for business purposes. So if you’re looking at buying a car near the end of the year, and you’re a calendar year taxpayer, be sure to put at least one mile on it before December 31 to show it was placed in service before the end of the year.
Vehicles Eligible for 100% Bonus
If you purchase a pickup, SUV, or van — but not a passenger vehicle such as a sedan — with a GVWR of greater than 6,000 pounds, it is eligible for bonus depreciation up to your bonus use percentage and assuming that you use the vehicle more than 50% of the time for business. (This latter requirement is because automobiles are considered to be listed property by the IRS.)
So let’s say you buy a new truck with a GVWR of 7,000 pounds for $80,000. You use this vehicle 75% of the time for business. In this case, you may take a bonus depreciation deduction of $60,000 on this vehicle.
Vehicles Eligible for Reduced Bonus
If your vehicle has a GVWR of 6,000 pounds or less, you can’t take 100% bonus depreciation on it. However, you can take bonus depreciation of up to $8,000 on this vehicle for the tax year ended December 31, 2019, in addition to standard MACRS depreciation.
Bonus and Section 179
Bonus depreciation is similar to another component of the tax code allowing for immediate expensing of otherwise capitalized assets, Section 179.
Bonus vs. Section 179
The table below summarizes the similarities and differences between bonus depreciation and Section 179.
|Characteristic||Bonus Depreciation||Section 179|
|Ability to pick and choose assets to expense||Taxpayer may select which classes of property on which to take bonus depreciation, but not individuals assets.||Taxpayer may elect Section 179 expensing on an asset-by-asset basis.|
|Effect on midquarter convention||None||Assets expensed under Section 179 are not considered for midquarter convention purposes.|
|Effect on Alternative Minimum Tax (AMT)||Assets subject to bonus depreciation are treated the same for Alternative Minimum Tax depreciation.||Assets subject to Section 179 expensing are treated the same for Alternative Minimum Tax depreciation.|
|Limitations based on taxpayer's income||No limitation||Section 179 expense may not be taken if the taxpayer is in a net loss position.|
|Maximum deduction allowed||No limitation||$1,000,000|
|Limitation based on capital purchases||No limitation||Once taxpayer places in service $2,500,000 of assets during the year, the Section 179 limit of $1,000,000 begins to phase out and phases out completely at $3,500,000 of placed-in-service assets during the year.|
|State considerations||Nearly half of states do not conform. About ten conform completely, and the rest conform with modification.||41 states conform with 9 imposing a $25,000 maximum deduction with phaseout beginning at $200,000.|
Which to Choose?
As can be seen from the table above, there are pros and cons to both bonus depreciation and Section 179 expensing.
For starters, any taxpayer is eligible for bonus depreciation on their qualifying assets. The Section 179 expense rules, however, preclude some taxpayers from expensing their otherwise qualifying assets under Section 179.
However, when it comes to flexibility in terms of designating specific assets to be immediately expensed, Section 179 is the clear winner. So if you desire your taxable income to be at very specific level, Section 179 may be the superior option over bonus depreciation, which forces you to opt out on a class-by-class rather than asset-by-asset basis.
Finally, if your assets may otherwise be subject to the midquarter convention, it is possible to take the Section 179 expense on assets placed in service in the fourth quarter in order to avoid the midquarter convention if you so choose.
Bonus and Listed Property
The IRS has established that certain kinds of property are “listed” property. This means that they’re on a particular “list” of assets that taxpayers tend to use for both personal and business use.
What Is Listed Property?
Listed property includes:
- Cameras and other recording equipment
- Property used for entertainment or amusement
Listed Property Eligibility for Bonus Depreciation
An item that is listed property must be used greater than 50% for business use during the year. For vehicles, this is determined on a mileage basis. For other assets, this is determined by time spent using the item.
So if you drove a vehicle 100,000 miles during the year, and only 40,000 of those miles were for business use, the vehicle would not qualify for bonus depreciation. If you drove that vehicle 60,000 miles for business use, however, it would be eligible for bonus depreciation, but only up to 60% of its cots.
Similarly, if you used a camera for 1,000 hours during the year and only used it 300 hours for business use, it would not be eligible for bonus depreciation. If you used the camera for 750 hours for business use, it would be eligible for bonus depreciation, but only up to 75% of its cost.
State Bonus Depreciation
Remember, bonus depreciation is a creation of federal income tax law.
How States Treat Bonus Depreciation
Some states conform their tax law to the federal bonus depreciation provisions, others partially conform, and still others do not conform at all and therefore do not permit bonus depreciation to be taken.
Remember, no matter what state you live in, you can take bonus depreciation on your federal income tax return. However, you need to be aware of the state rules concerning bonus depreciation in the states that you file income tax returns in.
And this isn’t always something that you can trust your tax software for; even as a tax professional using high-powered tax software, I see the software sometimes making mistakes when it comes to calculating depreciation for state income tax purposes.
Below is the tax treatment of bonus depreciation in each of the fifty states.
Bonus Depreciation by State
|State Name||Bonus Conformity|
|Alabama||Conforms except for assets placed in service in 2008.|
|Alaska||Conforms except for certain oil and gas producers.|
|Arizona||Does not conform.|
|Arkansas||Does not conform.|
|California||Does not conform.|
|Connecticut||Does not conform, but amount disallowed may be taken equally over four successive years.|
|District of Columbia||Does not conform.|
|Florida||Does not conform for assets placed in service after 2007, but amount disallowed may be taken equally over seven successive years.|
|Georgia||Does not conform.|
|Hawaii||Does not conform.|
|Idaho||Conforms only for property placed in service in 2008 and 2009.|
|Indiana||Does not conform.|
|Iowa||Conforms only for property placed in service between May 6, 2003, and December 31, 2004.|
|Kentucky||Does not conform.|
|Maine||Does not conform but offers a capital investment tax credit up to 9% of the disallowed bonus depreciation.|
|Maryland||Does not conform.|
|Massachusetts||Does not conform.|
|Michigan||Does not conform but from 2008 - 2011 offered a Michigan Business Tax credit for federal bonus depreciation.|
|Minnesota||Does not conform.|
|Mississippi||Does not conform.|
|Nebraska||Conforms except for a modified calculation for property placed in service between September 11, 2001, and December 31, 2005.|
|Nevada||Nevada does not impose a personal or corporate income tax.|
|New Hampshire||Does not conform.|
|New Jersey||Does not conform.|
|New York||Does not conform except for certain resurgence zone property and qualified New York Liberty Zone property.|
|North Carolina||Does not conform. Requires 85% of the federal bonus depreciation amount to be added back on the state return. This amount disallowed may be taken equally over five successive years.|
|Ohio||Does not conform.|
|Oklahoma||Conforms except for a modified calculation for property placed in service between January 1, 2008, and December 31, 2009.|
|Oregon||Conforms except for tax years 2009 and 2010.|
|Pennsylvania||Does not conform.|
|Rhode Island||Does not conform.|
|South Carolina||Does not conform.|
|South Dakota||South Dakota does not impose a personal or corporate income tax.|
|Tennessee||Does not conform.|
|Texas||Does not conform.|
|Vermont||Does not conform.|
|Virginia||Does not conform.|
|Washington||Washington does not impose a personal or corporate income tax.|
|Wisconsin||Does not conform.|
|Wyoming||Wyoming does not impose a personal or corporate income tax.|
Logan is a practicing CPA and founder of Choice Tax Relief and Money Done Right. After spending nearly a decade in the corporate world helping big businesses save money, he launched his blog with the goal of helping everyday Americans earn, save, and invest more money. Learn more about Logan.