Definition
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 and equipment, rather than write them off over the “useful life” of that asset. It’s called ‘bonus’ depreciation because it’s generally taken in addition to the standard depreciation deduction. This incentive is used to encourage businesses to invest in capital expenditures and stimulate economic growth.
Phonetic
The phonetics for the keyword “Bonus Depreciation” are:Bonus: ‘Boh-nuhs’Depreciate: ‘dih-pre-shee-ey-shuhn’
Key Takeaways
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- Immediate Expense Deductions: Bonus depreciation allows businesses to immediately deduct a significant portion of the purchase price of eligible business assets, rather than depreciating the cost over the asset’s useful life. This can significantly lower a company’s taxable income in the year of purchase.
- Eligibility of Assets: Only business assets that have a useful life of 20 years or less, such as machinery, equipment, computers, appliances and furniture, are eligible for bonus depreciation. Some intangible property like software, certain types of real property like a qualified improvement property, and certain fruits and nuts specified by the IRS are also eligible.
- 100% Deduction Under TCJA: The Tax Cuts and Jobs Act (TCJA) has increased the bonus depreciation deduction to 100% for qualified property purchased and placed in service after September 27, 2017, and before January 1, 2023. This gives businesses a unique opportunity for immediate tax savings.
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Importance
Bonus Depreciation is an important term in business/finance because it allows businesses to deduct a significant portion of the purchase price of business assets. This tax incentive encourages businesses to invest in new assets such as machinery, equipment, vehicles, or software, which can drive business growth and economic expansion. This deduction, which is usually a percentage set by law, can be claimed in the year these assets are placed in service, allowing businesses to reduce their taxable income. It is particularly beneficial for businesses to take advantage of bonus depreciation in years of high profitability, to offset the cost of significant capital investments. Thus, understanding how and when to utilize bonus depreciation is critical for effective tax planning and overall financial management for businesses.
Explanation
Bonus depreciation is a tax incentive that aims to stimulate business investment in different assets, such as machinery, equipment, vehicles, etc., offering significant advantages to businesses in the financial management of these investments. The main purpose of bonus depreciation is to speed up the depreciation process, permitting businesses to apply a higher percentage of cost depreciation in the first year an asset is placed in service. This front-loaded method often results in substantial tax savings for businesses, assisting them in managing their cash flows better and encouraging further investments in assets.In terms of its usability, businesses leverage bonus depreciation to lessen their taxable income. When a business purchases a qualifying asset, instead of depreciating the asset’s cost over several years, the business can deduct a large percentage of the asset’s cost in the year the asset is placed into service. This immediate tax deduction reduces the business’s taxable income for that year, thereby reducing the amount of taxes it owes. Consequently, bonus depreciation can play a crucial role in a company’s financial planning and strategic investment decisions.
Examples
Bonus depreciation is a tax incentive that allows a business to immediately deduct a large percentage of the purchase price of eligible business assets, instead of writing them off over the “useful life” of that asset.1. Commercial Real Estate Investments: If a real estate development company purchases a commercial property that is eligible for bonus depreciation, they can depreciate a large percentage of the cost in the first year. For instance, if a company purchases a commercial property for $1 million, under bonus depreciation, they might be able to depreciate (and therefore write off) 50% of that cost in the first year, reducing their taxable income by $500,000.2. Purchase of Machinery and Equipment: A manufacturing company purchases a new machinery for $500,000. With the bonus depreciation, they might be able to deduct 100% of the cost in the first year under the Tax Cuts and Jobs Act of 2017, instead of depreciating it over several years. This would significantly lower the company’s taxable income for that year.3. Acquisition of Vehicles for Business Use: A transportation company purchases a fleet of 50 new vehicles for $2 million. Using bonus depreciation, they could potentially deduct the full cost in the first year, providing them with significant tax savings. This is subject to certain restrictions about the weight and type of vehicle and other conditions.
Frequently Asked Questions(FAQ)
What is bonus depreciation?
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, equipment, furniture, software and vehicles, instead of writing them off over the ‘useful life’ of the items.
Who can take bonus depreciation?
Businesses, regardless of size, that purchase and use qualifying business assets are eligible for bonus depreciation. However, to take advantage of it, the asset must be used more than 50% of the time for business purposes.
On what type of assets can bonus depreciation be applied?
Bonus depreciation can be applied on tangible property such as machinery, equipment, furniture, vehicles which have a useful life of 20 years or less. It may also apply to off-the-shelf computer software and certain improvements to non-residential real property.
Can bonus depreciation be used on used assets?
Previously, bonus depreciation was available only for new property. However, under the Tax Cuts and Jobs Act (TCJA) of 2017, it can now be applied to used property as well, provided the business taxpayer had not previously used the acquired asset and the asset was not acquired from a related party.
What is the difference between bonus depreciation and Section 179?
While both bonus depreciation and Section 179 allow businesses to expense capital purchases in the year of purchase, there are key differences. Bonus depreciation can be used with a net loss where Section 179 cannot. Bonus depreciation can create or increase a net operating loss, while Section 179 cannot. Furthermore, there is no spending cap with Bonus Depreciation, while Section 179 has a cap of $1,050,000 in 2021.
Does bonus depreciation have to be taken?
No, bonus depreciation is optional. Businesses may choose to forgo it, if for instance, they anticipate being in a higher tax bracket in future and prefer to spread out the deductions over a longer period of time.
What is the current rate of bonus depreciation?
The current rate of bonus depreciation is 100% for qualified assets. Recent tax reforms under the TCJA set this rate for assets acquired and placed into service after September 27, 2017 and before January 1, 2023.
How is bonus depreciation reported on tax returns?
Bonus depreciation is generally reported on IRS Form 4562: Depreciation and Amortization, and attached to your business tax return.
Related Finance Terms
- Capital Expenditure: Also known as CapEx, this refers to the funds used by a company to acquire or upgrade physical assets such as property, industrial buildings, or equipment. They are often associated with bonus depreciation as the purchased assets may be eligible for such a bonus.
- Section 179 Deduction: This provision in the U.S. Tax Code allows businesses to deduct the full purchase price of qualifying assets purchased during the tax year. It’s sometimes confused with bonus depreciation, but these two are different in terms of eligibility and limits.
- Tangible Property: These are physical assets (like machinery, buildings, medical equipment) that a company owns. Under certain circumstances, the cost of these assets can be depreciated over their useful life, with some percentage of the cost eligible for bonus depreciation in the first year.
- Taxable Income: This is the amount of an individual’s or company’s income used to calculate how much they owe in taxes. With bonus depreciation, a company will have a lower taxable income because the cost of the assets is deducted from their income.
- Asset Lifespan: This refers to the estimated operational lifespan of a firm’s asset. It guides the depreciation schedule, dictating how the cost of an asset will be distributed over the years. Bonus depreciation allows business to deduct a high percentage of the asset’s cost in the first year, regardless of its expected lifespan.
