To run your business efficiently, you need good equipment and machinery. You may want to add to or replace what you have now. Newer versions usually run faster and smarter, and may be more energy efficient. In order to help businesses afford investments in such property, the tax law permits special write-offs up front. There is a Sec. 179 deduction (called “first-year expensing”), which is capped at an annual dollar amount ($1,020,000 in 2019 for most types of property). There is also a special allowance you can take to write off the cost of certain property, which is referred to as bonus depreciation.
Here are 10 things to keep in mind for claiming bonus depreciation.
- Bonus depreciation isn’t an extra write-off. It merely accelerates what you’d be able to deduct over the life of the property through regular depreciation.
- It is 100% of the cost of qualified property bought and placed in service in 2019. There is no dollar limit on the annual deduction. But the percentage for bonus depreciation is scheduled to decline as follows: 80% in 2023, 60% in 2024, 40% in 2025, 20% in 2026, and no bonus depreciation in 2027 unless Congress extends it.
- It can be used for both new and pre-owned property. In the past, the write-off had been limited to new property. But as long as the property isn’t acquired from a “related party,” even used property can qualify for bonus depreciation.
- It can be used regardless of whether the purchase is financed in whole or in part. For example, if you buy a machine costing $20,000 in 2019 and finance $15,000 of the purchase price, you can deduct $20,000 using bonus depreciation in 2019.
- Bonus depreciation applies automatically. No special election is required. However, if you don’t want to use it (e.g., perhaps you expect to be more profitable in the future so that deductions become more valuable to you later on), you must elect out of bonus depreciation for all property within the same class that’s placed in service in the same year (e.g., all 5-year recovery period property placed in service in 2019). The election is made by attaching your own statement to the tax return for the year in which the property is placed in service. Once you make the election, it’s irrevocable.
- It is claimed on Form 4562. Section II is used for this purpose for most property. But for vehicles, use Part V.
- Qualified property isn’t limited to tangible property, such as machinery and equipment. It can also be used for certain plants bearing fruits and nuts; film, television, and theatrical productions; and off-the-shelf computer software.
- Bonus depreciation is in addition to any Sec. 179 first-year expensing for property purchases. In other words, if you elect to use the Sec. 179 deduction, it applies before any bonus depreciation. For example, if you acquire a heavy SUV in 2019 that’s used 100% for business, you can take a Sec. 179 deduction of $25,500 (this limit is different from the limit that applies to most property as mentioned earlier). The balance of the cost of the vehicle is deductible using bonus depreciation.
- It may create or increase a net operating loss. You don’t have to be profitable from a tax perspective to take the deduction. You may be able to afford the needed property by financing the purchase. Why does this matter? Because bonus depreciation is different from the Sec. 179 deduction in this regard: the Sec. 179 cannot be claimed if you aren’t profitable but there’s no similar requirement for bonus depreciation.
- There is depreciation recapture on the disposition of property for which bonus depreciation is claimed. This means that gain on the sale of property for which bonus depreciation was claimed is treated as ordinary income (not capital gain) to the extent of this deduction.
You can find more details about bonus depreciation in IRS Publication 946, How to Depreciate Property. Also, be aware that state income tax rules on bonus depreciation may differ from federal rules explained here. Consult with your tax advisor.