Bonus depreciation

Definition

Bonus depreciation allows businesses to immediately deduct a significant portion of the cost of qualified property in the year the property is placed in service. This provision provides a tax incentive aimed at encouraging capital investment by allowing companies to recover their costs more quickly, thus impacting cash flow and financial planning. It closely interacts with various depreciation methods and can influence timing strategies for income and deductions, optimizing tax benefits.

5 Must Know Facts For Your Next Test

1. Bonus depreciation was increased to 100% under the Tax Cuts and Jobs Act for property placed in service from 2017 through 2022, allowing businesses to deduct the full cost immediately.
2. Bonus depreciation can be claimed on both new and used qualified property, which broadens its applicability for businesses looking to invest.
3. For property acquired after September 27, 2017, the bonus depreciation deduction will begin phasing down by 20% each year starting in 2023.
4. Unlike Section 179, bonus depreciation is not limited by income; it can create a net operating loss (NOL) that can be carried back or forward.
5. The decision to take bonus depreciation versus other forms of depreciation can significantly affect a business's taxable income and tax liability in any given year.

Review Questions

• How does bonus depreciation interact with MACRS and what advantages does it provide for businesses?
  • Bonus depreciation supplements MACRS by allowing businesses to deduct a larger portion of the cost of qualified property upfront rather than spreading it out over several years. This immediate expensing can provide significant cash flow benefits as companies can recover costs more quickly. Additionally, because it applies to both new and used property, it offers more flexibility than traditional MACRS methods alone, making it an attractive option for many businesses looking to invest in capital assets.
• Compare and contrast bonus depreciation with the Section 179 deduction in terms of eligibility and impact on taxable income.
  • Both bonus depreciation and the Section 179 deduction allow for accelerated recovery of asset costs but differ in key aspects. Bonus depreciation applies broadly to new and used property without income limitations and can generate net operating losses, while Section 179 is limited to new equipment purchases and is capped by the taxpayer's income level. Choosing between them affects taxable income differently; bonus depreciation generally results in larger deductions upfront while Section 179 allows for more strategic planning based on a company's income.
• Evaluate the strategic implications of utilizing bonus depreciation in tax planning for a business over multiple years.
  • Utilizing bonus depreciation can significantly alter a business's tax strategy by enhancing short-term cash flow through immediate deductions. In years when a company anticipates high earnings, taking full advantage of bonus depreciation can reduce tax liability substantially. However, in years with lower earnings, this upfront deduction could lead to NOLs that may not be beneficial if not utilized effectively in subsequent years. Businesses must consider their overall growth trajectory and profit forecasts when determining how much bonus depreciation to take in order to optimize their tax positions over time.

Related terms

MACRS: Modified Accelerated Cost Recovery System, the primary depreciation method used in the United States, which allows businesses to recover investments in tangible property over specified periods.

Qualified Property:

Property that is eligible for bonus depreciation, which generally includes new or used tangible property with a useful life of 20 years or less, certain improvements to nonresidential real property, and some software.

Section 179 Deduction:

A tax deduction that allows businesses to deduct the full purchase price of qualifying equipment and software purchased or financed during the tax year, subject to certain limits.