- Business owners should maximize deductions and depreciations as part of their taxation strategy.
- While most owners use regular asset depreciation during tax time, many do not consider the benefits of bonus depreciation.
- Depreciation allows a business to write off assets at fair market value or its cost over the projected time it will be used. Bonus depreciation allows owners to accelerate this process.
- This article is for business owners who want to take advantage of bonus depreciation when filing their taxes.
Every business owner wants to find ways to maximize their deductions and depreciation for important business assets each year. While you probably already take advantage of regular asset depreciation, you may not be benefiting from bonus depreciation.
Not sure what bonus depreciation is or how it works? This guide will break down how to apply bonus depreciation to your expensive assets during tax season this year.
What is bonus depreciation?
Depreciation is a taxation strategy that lets a business write off an asset's fair market value or cost over a projected useful life (how long the company estimates the asset will be used for business needs).
For example, a moving company uses a large truck for its primary business activities. The truck costs $100,000, and when the business purchases it, the owner estimates that the company will use the truck for 10 years. That means they can write off $10,000 worth of expenses on their tax returns each year up until the 10-year limit.
That's a significant write-off, but not necessarily enough for most business owners. That's where bonus depreciation comes in.
Bonus depreciation lets business owners accelerate the depreciation process. Businesses can then write off more than a single year's cost of an asset in the same year they start using it. In the above example, that business owner could write off more than $10,000 when they purchased the truck for that tax year.
How much bonus depreciation allows you to write off depends on the tax year. According to the Tax Cuts and Jobs Act of 2017 (TCJA), businesses can write off up to 100% of the cost for any eligible assets or property purchased after Sept. 27, 2017, and before Jan. 1, 2023. Previously, business owners could write off only up to 50% of a given asset.
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While this sounds great now, the 100% write-off limit will start to decrease after 2022. According to Nolo, the depreciation bonus rate will decrease as follows over the next few years:
- 2023: Max depreciation up to 80%
- 2024: Max depreciation up to 60%
- 2025: Max depreciation up to 40%
- 2026: Max depreciation up to 20%
To recap, businesses can normally write off only one year's cost of a given asset to get a better tax return. Bonus depreciation allows businesses to write off more than a single year's cost of the asset instead. [Read related article: Which Business Assets Are Tangible?]
FYI: Bonus depreciation can now be applied to property. Before the TCJA, only new property qualified for bonus depreciation on tax returns. Be sure to read the IRS' rules on using property bonus depreciation carefully.
How does bonus depreciation work?
To take advantage of bonus depreciation, you'll start by determining whether you have any qualified business property. Once you've discovered you have qualifying property, you must start using the asset in the appropriate tax year.
For instance, the moving company described above purchased a new moving truck in December 2021. However, they don't plan to start using it until January 2022. In that case, the company would need to wait until filing their 2022 tax return to claim any bonus depreciation on the moving truck.
Next, the company must claim the bonus depreciation on the business's tax returns. In the above example, the moving company could claim up to 100% depreciation for the cost of the moving truck using Form 4562. This form is filed alongside the primary business tax return paperwork.
Electing out of bonus depreciation
Although bonus depreciation can be helpful, some businesses may want to opt out. Here are a few reasons you may want to elect out of bonus depreciation:
- You want your tax returns to be more stable or consistent.
- You missed the window to depreciate 100% of the cost.
- Your accountant advises you not to take a bonus depreciation.
You're never forced to take bonus depreciation for assets, and you can opt out by attaching a statement to your business tax returns.
However, each bonus depreciation opt-out must be made separately by every owner. In such circumstances, you may use MACRS depreciation methods or other strategies instead.
How do you qualify for bonus depreciation?
While bonus depreciation is technically available for every business owner, only certain types of property qualify. Let's look at how you can qualify for bonus depreciation.
For your business to qualify for bonus depreciation, it must have business property that meets at least one of the following criteria:
- It has a maximum useful life of 20 years or less. Land and buildings are excluded, for example, since these assets could be used for much longer than 20 years.
- It's a qualified improvement property, which covers properties that improve the interiors of nonresidential real properties or commercial buildings.
- It is used for qualified film, television or live theater productions.
- It can be used for both business and personal use (e.g., cameras and vehicles).
There are also multiple restrictions for how bonus depreciation can be used on vehicles. The IRS has different bonus depreciation limits for vehicles so that business owners can't claim large tax deductions on cars that are primarily for personal use.
The bottom line is that bonus depreciation can be used only on property that your business owns, is used for income-producing activities, and has a determinable useful life. The IRS keeps a detailed list of all the qualifying property types for regular and bonus depreciation.
There are also some restrictions to keep in mind when claiming bonus depreciation. In addition to the above restrictions on listed property, you cannot use the entire bonus depreciation amount if you also use the Section 179 expense deduction, which allows your business to write off the cost of a certain qualified property right away. It serves a similar purpose as bonus depreciation, but it's not exactly the same.
For example, you can't claim Section 179 unless you have a taxable profit to report. Say that your business has just $10,000 in taxable income before taking the Section 179 deduction. From there, you decide to purchase $20,000 worth of machinery or equipment. Your Section 179 deduction is limited to just $10,000. Then you can either claim regular depreciation on the remaining $10,000 or carry the unused deduction into the next tax year.
How to record bonus depreciation on your tax return
Recording or claiming the bonus depreciation for an asset on your tax return is fairly simple. Just use IRS Form 4562, which allows you to record and review any bonus depreciation your business has taken.
This same form will be used to claim any other types of depreciation, like the Section 179 deduction. Review the full instructions for Form 4562 to ensure you don't miss anything and that you calculate your bonus depreciation accurately.
FYI: The right accounting software can help you keep track of bonus depreciation so that you're ready for tax season. Check out our reviews of the best accounting software and our list of the best small business tax software for small businesses.
Business owners can use bonus depreciation to lower their taxable income on their tax returns. Bonus depreciation can help you maximize the value of a newly purchased asset sooner rather than later.
However, make sure to use bonus depreciation carefully and when it makes economic sense. You might want to consider using an accountant before leveraging bonus depreciation, especially across multiple assets.