Bonus depreciation

Definition

Bonus depreciation is a tax incentive that allows businesses to deduct a significant percentage of the cost of qualified assets in the year they are placed in service, rather than spreading the deduction over the useful life of the asset. This provision helps businesses to recover costs more quickly and provides an immediate cash flow benefit, making it a crucial consideration in financial planning and investment decisions.

5 Must Know Facts For Your Next Test

1. The Tax Cuts and Jobs Act of 2017 expanded bonus depreciation to allow a 100% deduction for qualified property placed in service from 2017 through 2022.
2. Bonus depreciation applies to new and used property, providing flexibility for businesses purchasing both types of assets.
3. After 2022, the percentage of bonus depreciation begins to phase down, decreasing by 20% each year until it reaches zero in 2027 unless new legislation is enacted.
4. Businesses can elect out of bonus depreciation for certain properties if it is more beneficial to use other depreciation methods.
5. Bonus depreciation can significantly impact a company's taxable income, improving cash flow and influencing investment decisions.

Review Questions

• How does bonus depreciation affect business decision-making regarding asset purchases?
  • Bonus depreciation plays a vital role in business decision-making by allowing companies to recover the costs of their investments more quickly. When considering purchasing new equipment or property, businesses can evaluate how much they can deduct immediately versus spreading deductions over time. This immediate cash flow benefit can influence whether a company chooses to invest in new assets or delay purchases based on potential tax implications.
• Compare and contrast bonus depreciation with Section 179 expensing in terms of eligibility and impact on financial statements.
  • Both bonus depreciation and Section 179 expensing allow businesses to recover costs for asset purchases, but they have different eligibility criteria and implications. Bonus depreciation applies automatically to qualified property and can be claimed regardless of the total amount spent, while Section 179 has annual limits on the amount that can be deducted based on the total capital expenditure. Additionally, Section 179 expensing requires that assets must be new or used but also acquired for business use, affecting how these deductions are reflected on financial statements.
• Evaluate the long-term implications of using bonus depreciation on a company's financial health and tax strategy.
  • Using bonus depreciation can provide immediate tax relief and enhance cash flow in the short term, allowing businesses to reinvest savings into growth opportunities. However, this strategy may lead to lower depreciation deductions in future years since fewer deductions will be available when assets are placed in service. Companies must consider how their current tax strategy aligns with long-term financial goals, as relying heavily on bonus depreciation could result in higher taxable income in subsequent years when they have fewer deductions available.

Related terms

Qualified Property:

Assets that are eligible for bonus depreciation, which generally includes tangible property with a recovery period of 20 years or less.

MACRS: Modified Accelerated Cost Recovery System, which is the standard method of depreciation used for tax purposes in the United States, allowing for accelerated deductions over a specified recovery period.

Capital Expenditure: Funds used by a business to acquire or upgrade physical assets such as property, industrial buildings, or equipment, which can be impacted by depreciation strategies.