Definition
Bonus Depreciation is a tax incentive that allows a business to immediately deduct a large portion of the purchase price of eligible business assets, instead of writing them off over the “useful life” of that asset. This can be a significant benefit for businesses, reducing their tax liability and encouraging investment in new assets. The percentage that can be deducted varies, but under recent changes in U.S. law, it can be up to 100%.
Key Takeaways
- Bonus Depreciation is a tax incentive that allows a business to immediately deduct a large percentage of the purchase price of eligible business assets, rather than write them off over the “useful life” of that asset.
- Bonus Depreciation is most commonly used by businesses when there has been an unplanned capital expenditure. This means that the company can reduce its tax burden in the current year by taking full advantage of the depreciation that will occur in future years.
- The Tax Cuts and Jobs Act, signed into law by President Trump in 2017, increased the Bonus Depreciation from 50% to 100% for qualified property acquired and placed in service after September 27, 2017, and before January 1, 2023.
Importance
Bonus Depreciation is a significant finance term because it’s a tax incentive that allows businesses to immediately deduct a large percentage of the purchase price of eligible business assets, instead of depreciating the cost over the lifespan of the asset.
This incentive can stimulate investment and economic growth by making it less costly for businesses to buy equipment and invest in themselves, ultimately leading to increased productivity.
Bonus depreciation can significantly influence a company’s financial strategy and tax liability, aiding businesses in their overall financial planning and potential profitability.
Explanation
Bonus depreciation is a tool utilized by businesses to accelerate their tax depreciation benefits. This allows for the rapid deduction of the cost of business assets, in their first year of use rather than depreciating the cost over the typical useful lifespan of the asset.
Therefore, the primary purpose of bonus depreciation is to incentivize businesses to purchase new assets which, in turn, stimulates economic activity and growth. The application of bonus depreciation is primarily beneficial when a business is making significant capital investments, such as the purchase of machinery or equipment.
By permitting a large portion of the asset’s cost to be deducted in the first year, a company can reduce its taxable income thereby saving on tax costs. Ultimately, these deductions can help balance out initial capital outlay, making major asset acquisition more attractive for a business.
Bonus depreciation truly serves as a strategic tax planning tool that can significantly influence a business’s investment decisions.
Examples of Bonus Depreciation
Purchase of Machinery Equipment: A manufacturing company decides to expand their production line by purchasing new machinery. The cost of this machinery is $500,
According to bonus depreciation rules, the company can deduct a certain percentage (say, 100% as per the Tax Cuts and Jobs Act) of the cost of the machinery within the first year of purchase. This allows the company to significantly reduce its taxable income for that year.
Investment in Vehicles: A trucking company buys a fleet of trucks to expand its operations. These trucks, seen as an investment, qualify for bonus depreciation, allowing the company to deduct a percentage of their cost in the first year of operation. Given that vehicles depreciate fairly quickly, this is an example of how bonus depreciation rules can help businesses manage the costs of such assets.
Construction of Buildings: A real estate developer invests in constructing commercial buildings. While generally, the depreciation of these assets is spread out over several years, certain aspects of the project could qualify for bonus depreciation, such as improvements made to the property like roofing, HVAC system, fire alarms, security systems, etc. This way, the developer could reduce its taxable income significantly in the year these expenses occurred.
Bonus Depreciation FAQ
What is Bonus Depreciation?
Bonus depreciation is a tax incentive that allows business owners to report a chunk of depreciation in the year they purchase the asset. This speeds up their reward for investment.
Who can claim Bonus Depreciation?
Business property owners who make capital investments on a qualifying property are eligible to claim bonus depreciation.
How is Bonus Depreciation calculated?
Bonus depreciation is calculated by multiplying the cost of the asset by the percentage of bonus depreciation. Currently, bonus depreciation is 100%, so the entire cost of the asset can be written off in the first year.
What is the purpose of Bonus Depreciation?
The purpose of bonus depreciation is to boost investment and economic activity by allowing businesses to deduct the cost of qualifying assets more quickly.
What is a qualifying asset for Bonus Depreciation?
A qualifying asset is one that has a recovery period of 20 years or less and is not a building or a structural component. Examples include equipment, machinery, computers, software, office furniture, vehicles, and more.
Related Entrepreneurship Terms
- Capital Expenses
- Section 179 Deduction
- Depreciation Schedule
- Cost Recovery
- Taxable Income
Sources for More Information
- Internal Revenue Service (IRS): This is the official website of the U.S. government agency responsible for tax collection and tax law enforcement. It provides a variety of information on taxation issues, including bonus depreciation.
- Investopedia: This site is a comprehensive resource for learning about finance and investing. It offers many articles, tutorials, and guides on a wide range of topics, including bonus depreciation.
- American Institute of Certified Public Accountants (AICPA): The AICPA is the world’s largest member association representing the accounting profession. It provides resources for accounting and finance professionals, including information on bonus depreciation.
- BDO USA LLP: BDO is one of the nation’s leading accounting and advisory firms. They have an excellent knowledge base on finance topics, including bonus depreciation. Their resources are usually very detailed and insightful.
