What is Bonus Depreciation and How to Use This to Your Advantage

Introduction:

In recent years, the tax landscape for businesses has seen several changes, with bonus depreciation being one of the most significant and beneficial. For business owners, understanding bonus depreciation is crucial as it offers an opportunity to maximize deductions and reduce tax liabilities. In this post, we’ll dive deep into what bonus depreciation is, how it works, and how you can use it to your advantage.

What is Bonus Depreciation?

Bonus depreciation is a tax incentive that allows businesses to deduct a significant percentage of the cost of qualifying assets in the year they are placed into service, rather than spreading the deduction out over several years. This is a departure from traditional depreciation, where assets are typically depreciated over time according to their useful life.

For many businesses, bonus depreciation can lead to significant upfront savings. For example, if you purchase new equipment for your business, instead of depreciating it over five to seven years, you could potentially deduct 100% of the cost in the first year—depending on the current rules.

Key Aspects of Bonus Depreciation:

1. The Tax Cuts and Jobs Act (TCJA) of 2017:
   The TCJA significantly expanded bonus depreciation, allowing businesses to deduct 100% of the cost of qualifying property purchased and placed into service after September 27, 2017, and before January 1, 2023. The deduction will phase down gradually starting in 2023.

2. What Qualifies for Bonus Depreciation?
   Generally, tangible property with a useful life of 20 years or less qualifies for bonus depreciation. This includes machinery, vehicles, equipment, computers, and even certain improvements to nonresidential real property (such as HVAC systems or roofs). Some exceptions apply, and businesses should review each asset’s qualification carefully.

3. Bonus Depreciation and Used Property:
   Unlike previous iterations of bonus depreciation, businesses can now also claim this deduction on used property—not just new purchases—if the property meets the qualifying criteria.

4. Phase-Out and Limitations:
   The full 100% deduction will begin to phase down starting in 2023. The depreciation rate is set to reduce by 20% annually:

   • 2023: 80% bonus depreciation

   • 2024: 60% bonus depreciation

   • 2025: 40% bonus depreciation

   • 2026: 20% bonus depreciation
     In 2027, bonus depreciation will revert back to the standard depreciation rules.

How Does Bonus Depreciation Benefit Your Business?

1. Immediate Tax Savings:
   By claiming bonus depreciation, businesses can significantly reduce their taxable income in the year they acquire a new asset. This could result in immediate tax savings, providing more cash flow to reinvest in the business. The upfront deductions can allow businesses to make major purchases that they might otherwise delay or avoid.

2. Increasing Cash Flow:
   Instead of waiting several years for the full depreciation benefit, businesses can immediately deduct a large portion of the asset’s value. This helps improve cash flow, which can be crucial for growth, paying off debts, or funding future projects.

3. Encouraging Investment:
   Bonus depreciation incentivizes businesses to invest in new equipment or property. If a business was considering an upgrade, the prospect of significant tax deductions may encourage a purchase sooner rather than later. This can help businesses remain competitive, invest in technology, or update outdated systems.

4. Benefit for Small Businesses:
   Small businesses often lack the capital to offset large upfront costs. Bonus depreciation helps bridge this gap by providing an immediate tax break on a portion of the investment. The immediate deduction helps level the playing field with larger businesses that might have more capital at their disposal.

How to Use Bonus Depreciation to Your Advantage

To maximize the benefits of bonus depreciation, businesses should strategically plan their asset purchases. Here are a few expanded tips:

1. Consider Timing Your Purchases:
   If you’re planning to purchase a major asset, consider doing so before the bonus depreciation phase-out begins in 2023. The closer you can get to taking advantage of the 100% deduction, the more you’ll save upfront. But it’s not only about large equipment. Even small-ticket items like software, tools, or machinery can qualify.

2. Evaluate All Eligible Assets:
   Don’t overlook assets like furniture, computer software, or even specific improvements to your office space. If the property qualifies, it can be depreciated using bonus depreciation. Make sure your business doesn’t miss out on qualifying assets by failing to consider items like new IT infrastructure, inventory management systems, or even business vehicles.

3. Consult a Tax Professional:
   Tax laws can be complex, and bonus depreciation may not be the best choice for every business. A tax professional can help determine whether bonus depreciation is right for your specific situation and guide you through the process. If you're unsure whether certain assets qualify or how to apply the deduction, professional help will save you time and potential headaches.

4. Plan for Future Taxes:
   While bonus depreciation can provide substantial savings in the short term, keep in mind that it could lead to higher tax liabilities in the future once the deduction phases out. Make sure you plan accordingly to avoid surprises in your future tax bills. If your business has significant capital expenditures planned for the next few years, consider working with a tax advisor to assess how the phase-out might impact your strategy.

5. Track Your Assets:
   One of the most important aspects of claiming bonus depreciation is proper documentation. You need to track each asset’s purchase price, date of acquisition, and depreciation method used. Many businesses use accounting software to stay on top of these records. Not only will this ensure you’re in compliance, but it’ll also help you optimize your depreciation schedule.

Common Misconceptions About Bonus Depreciation

Many business owners mistakenly assume that bonus depreciation only applies to large businesses or new assets. Here are a few myths to clear up:

1. Myth: Only Large Businesses Benefit
   In reality, any business that purchases qualifying property can benefit from bonus depreciation, regardless of its size. It’s designed to stimulate investment and help businesses of all sizes save on taxes.

2. Myth: Bonus Depreciation Applies Only to New Assets
   Unlike previous iterations of bonus depreciation, used assets are now eligible for the deduction, provided they meet the necessary criteria.

3. Myth: You Can't Claim Other Deductions if You Use Bonus Depreciation
   You can still take other tax deductions, such as Section 179, along with bonus depreciation. However, it's essential to consult with a tax professional to ensure you’re optimizing all available deductions.

Q&A: Common Questions About Bonus Depreciation

Q1: Can I claim bonus depreciation on property that I already own?
No, bonus depreciation only applies to property purchased and placed into service in the current tax year. However, if you purchase used property, you may still be eligible.

Q2: What happens if I sell an asset that I’ve taken bonus depreciation on?
If you sell an asset that you’ve depreciated using bonus depreciation, you may be required to recapture some of the deductions, meaning you could owe taxes on the amount you previously deducted.

Q3: Does bonus depreciation apply to vehicles or other transportation equipment?
Yes, bonus depreciation applies to new and used vehicles, including trucks, vans, and other equipment used for business purposes. However, vehicles have specific limits on the amount you can depreciate, especially for passenger vehicles.

Q4: Can I use bonus depreciation if I lease property instead of purchasing it?
No, bonus depreciation applies only to property that you purchase and own. If you're leasing an asset, you'll typically be able to deduct lease payments as a business expense, but you can’t apply bonus depreciation.

Q5: How does bonus depreciation differ from Section 179 deductions?
Section 179 allows businesses to expense the cost of qualified property up to a limit ($1,050,000 for 2021, with a phase-out at $2,620,000). Unlike bonus depreciation, Section 179 has a cap on how much you can deduct. The major difference is that bonus depreciation is often used for larger investments, whereas Section 179 is used for smaller assets.

Conclusion and Call to Action:

Bonus depreciation can be a powerful tool for businesses to reduce their tax liabilities and increase cash flow. By strategically planning purchases and consulting with a tax professional, businesses can leverage this tax benefit to their advantage and reinvest in their growth.

Want to maximize your tax savings?
Our team at Brecken Business Solutions is here to help you navigate the complexities of bonus depreciation and other tax strategies. Contact us today to schedule a consultation and ensure you’re making the most of available tax benefits!

References and Further Reading:

• IRS: Depreciation Methods for Business Property