Bonus Depreciation and How It Affects Business Taxes

Bonus Depreciation Explained
Bonus Depreciation Explained. Credit: mrPliskin/Getty Images

Bonus depreciation is a valuable tax-saving tool for businesses. It allows your business to take an immediate first-year deduction of 50% deduction on the purchase of eligible business property.

First, a brief review of the concept of depreciation, then details on how bonus depreciation works. 

UPDATE: In December 2015, Congress passed some changes to bonus depreciation, among other benefits to businesses.

This change includes: 

A five-year extension of bonus depreciation as an incentive to businesses for purchasing new equipment. The bonus depreciation amount will be at 50% for 2015, 2016, and 2017, reduced to 40% for 2018 and 2019. See below for more details.

What is Depreciation?

Depreciation allows (or requires) businesses to spread out the cost of long-term assets over the life of the asset. The alternative would be to take the cost of the asset in the first year after the asset is acquired by the business, but this isn't realistic. Hence, depreciation. 

The most common way to depreciate a business asset is by spreading out the cost evenly over the asset life - called straight-line depreciation. 

But, Congress has frequently given additional incentives to businesses over the past few years, to encourage them to purchase capital assets for their businesses. One such encouragement is bonus depreciation.

 

What is Bonus Depreciation?

Bonus depreciation is a method of accelerated depreciation which allows a business to make an additional deduction of 50% of the cost of qualifying property in the year in which it is put into service. This extra depreciation allowance is only for new equipment.

The IRS says:

This special bonus depreciation allowance is available to all businesses and applies to most types of tangible personal property and computer software acquired and placed in service [a particular year]. It allows taxpayers to deduct 50 percent of the cost of qualifying property in addition to the regular depreciation allowance that is normally available.  

How Bonus Depreciation Works

First, you make the purchase of qualified business property. Then you put the property in service, by setting it up and using it. 

Let's say the property is worth $1,000,000. First, you  may be able to take a Section 179 deduction, to reduce the purchase price. Then you may be able to take the additional bonus depreciation of 50% of the remaining basis. The balance of the purchase is then depreciated in the usual way. You can read more about how to calculate depreciation. 

Qualifications and Restrictions on Using Bonus Depreciation

To be qualified to use bonus depreciation, your business must be the original user of the property. The property must be new MACRS property placed in service (set up and used) before January 1, 2020. Only certain types of property may be eligible for bonus deprecation. Computer software is now included.

Check with your tax professional on this. 

There are maximums on the amount of bonus depreciation you can take in a year, but you may be able to carry over some of the tax savings into the next year. 

Bonus depreciation may be used in addition to Section 179 deductions, in some circumstances.

More on Bonus Depreciation for 2016 through 2019

Starting in 2016, bonus depreciation benefits have been extended through 2019. This is good, because it gives businesses a way to plan for purchases and taxes. 

Bonus depreciation benefits have been set through 2019 for most business property. The benefit is 50% in 2016 and 2017, 40% in 2018, and 30% in 2019. It expires beginning January 1, 2020, unless Congress extends it. 

The property you depreciate must be new, and placed in service (used) during the year you claim the benefit.

A new category of "qualified improvement property" has been added. As defined by the IRS, it is any improvement to a building interior of "nonresidential real property" (a building) that is placed in service after the date the building was first placed in service.

Recording Bonus Depreciation on Your Business Tax Return

Use IRS Form 4562 to record bonus depreciation and other types of depreciation and amortization. You might want to review the Instructions for Form 4562 before you begin this calculation. 

Getting Help with Bonus Depreciation

Depreciation is a complicated business process, and the laws regarding depreciation, particularly bonus depreciation and Section 179 deductions, are always changing. Before you make a business decision to buy new property and claim a bonus depreciation expense, talk to your tax professional. 

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