What qualifies for bonus depreciation?
What qualifies for bonus depreciation? When you purchase properties for your business, such as a computer or vehicle, that last for more than one year, it is expected that you deduct the cost of the property, a little at a time over several years. This process of deduction is known as depreciation expense in accounting. Depending on the kind of business property, it can take 3-39 years to fully depreciate the cost of a property.
However, Congress’ Job Creation and Worker Assistance Act of 2002 in an ongoing effort to help businesses, enacted bonus depreciation as a tax incentive that gives business owners the option of deducting a large percentage of the cost of a qualifying personal property used for business purposes, in the year that it is purchased. In this article, we will discuss this special depreciation allowance and what property qualifies for bonus depreciation.
Related: How to calculate bonus depreciation
Bonus depreciation explained
Bonus depreciation also known as additional first-year depreciation deduction or IRC §168 (k) depreciation is an accelerated business tax deduction that allows taxpayers to deduct a large portion of the purchase cost of qualifying assets in the first year.
Business taxpayers claim bonus depreciation in order to reduce the business’s income tax, which, in turn, reduces its tax liability. This business tax incentive accelerates depreciation by allowing taxpayers to write off a large percentage of the cost of a qualifying property in the first year that it was purchased; while the remaining cost of the qualifying property can be deducted using regular depreciation over multiple years until it phases out.
The Tax Cuts and Jobs Act (TCJA) passed in 2017 made notable changes to the rules for bonus depreciation. Before the TCJA, taxpayers could only write off 50% of the cost of a qualifying property in the first year that it was purchased. But with the passage of the TCJA, 100% bonus depreciation was enacted to allow business taxpayers to immediately write off 100% of the cost of a qualifying property purchased and placed in service after Sept. 27, 2017, and before Jan. 1, 2023.
Nonetheless, this 100% write-off of qualifying property expired on Dec. 31, 2022. Unless the bonus depreciation rules change, after Dec. 31, 2022, and before Jan. 1, 2027, the bonus percentage will decrease by 20 percent each year for qualifying property placed in service. That is, the phase-out schedule will be as follows over the next few years:
- For 2023, the bonus depreciation rate is 80%
- For 2024, the bonus depreciation rate is 60%
- For 2025, the bonus depreciation rate is 40%
- For 2026, the bonus depreciation rate is 20%
- For 2027, the bonus depreciation rate is 0%
See also: Is Accumulated Depreciation an Expense?
What qualifies for bonus depreciation?
In order to claim bonus depreciation, you have to, first of all, purchase a property that qualifies for bonus depreciation and put it into service prior to year-end. Then, you write off the percentage of the cost of the qualifying property on Form 4562, which is filed along with your business tax return. So, what qualifies for bonus depreciation? Certain criteria must be met for a property to qualify for a bonus depreciation deduction. Let’s look at some of the properties that qualify for bonus depreciation:
Assets eligible for bonus depreciation
- Property with a useful life of 20 years or less
- Depreciable computer software
- Water utility property
- Qualified improvement property
- Costs of qualified television or film productions or live theatrical productions
- Vacation property if used as a short-term rental
- Vehicles that have a useful life of 20 years or less
- Used property that has not been used by the taxpayer at any time prior to the acquisition
- Listed property used for both business and personal use
- Residential rental estate if a cost segregation study is conducted by the taxpayer
Here are the types of assets eligible for bonus depreciation:
Property with a useful life of 20 years or less
A property qualifies for bonus depreciation if it has a useful life of 20 years or less. That is, you can claim bonus depreciation on a Modified Accelerated Cost Recovery System (MACRS) property that has a recovery period of 20 years or less. Such property includes vehicles, machinery, equipment, computer equipment, office furniture, and fixtures. Land or buildings are not included because they could be used for much longer than 20 years. Therefore, land and buildings are not eligible for bonus depreciation.
Qualified improvement property
You can claim bonus depreciation on leasehold improvement property such as any improvement done to the interior portion of a rental property. When it comes to residential and rental properties, you cannot take bonus depreciation on the actual property. This is because rental properties have a minimum depreciation period of 27.5 years.
However, you can take bonus depreciation on the improvement done to the property. In order to for the improvement to qualify, it must be made after the building is open for business and more than three years after the date that the building was first placed in service.
Vacation property
Vacation property qualifies for bonus depreciation if the taxpayer is using the vacation property as a short-term rental. This property may qualify for bonus depreciation if the taxpayer improves the interior of the building.
Vehicles that have a useful life of 20 years or less
A vehicle qualifies for bonus depreciation if it has a useful life of 20 years or less. Nonetheless, there are multiple restrictions on how bonus depreciation can be used on vehicles. For vehicles, there are different bonus depreciation limits as specified by the IRS so that business owners can’t claim large tax deductions on vehicles that are mainly used for personal reasons.
Listed property used for both business and personal use
Some listed property qualifies for bonus depreciation. This includes property that tends to be used for both personal and business use like vehicles and cameras. However, for this property to qualify for bonus depreciation, it has to be used for business at least 50% of the time.
Used property that has not been used at any time before the acquisition
You can claim bonus depreciation on a used property though there are certain criteria to fulfill. Under prior law, you could only claim bonus depreciation for a new property but the Tax Cuts and Jobs Act has changed that rule and expanded the definition of qualified property to include used property.
Nonetheless, for a used property to be eligible for bonus depreciation, the taxpayer must not use the property at any time before acquiring it. For instance, if a business owner leases a piece of equipment before purchasing it, he would not be able to claim bonus depreciation on the equipment. Furthermore, for a used property to be eligible for bonus depreciation, the taxpayer must not have acquired the property from a related party or from a tax-free transaction, such as a like-kind exchange.
Read also: Adjusting Entry for Depreciation
