Since the 2017 Tax Cuts and Jobs Act, businesses have been allowed to write-off 100% of the cost of eligible property in the year the property is placed into service by using bonus depreciation. To qualify for bonus depreciation, the property placed into service must have a useful life of 20 years or less and be depreciated using the Modified Accelerated Cost Recovery System method. Property such as qualified improvement property, farm shops, car washes, computer software, vehicles, and equipment are all popular items that qualify for bonus depreciation.

There are many benefits to taking bonus depreciation. Unlike the Section 179 deduction, another method available for depreciating assets at an accelerated rate, bonus depreciation does not have a limitation on the maximum deduction. For tax years 2018-2022, the maximum bonus depreciation has been 100% of the cost of the qualified assets placed into service. For example, if a taxpayer buys (and places into service) a $100,000 qualified asset, they can take a $100,000 deduction in 2022. Bonus depreciation can also reduce income below zero, meaning it can create losses to offset other income and even create net operating losses. In contrast, Section 179 cannot be used to reduce business income below $0. As such, the maximum Section 179 deduction is limited to business income.

Another benefit to bonus depreciation is that it is an automatic deduction, meaning that the taxpayer receives it by default unless they opt out. If the taxpayer elects out of using bonus depreciation, they must do so for all property with the same useful life purchased in the year. For example, if a taxpayer buys two five-year assets and does not want to use bonus depreciation on one, they must elect out of using bonus depreciation on both, since both are five-year properties. This is one downside of bonus depreciation – it is not as flexible and easily tailored to the taxpayer’s needs. It is a one-size-fits-all approach to accelerated depreciation.

One downside to bonus depreciation is that the deduction rules are more volatile. The maximum deduction limit has changed drastically throughout recent years. Before the Tax Cuts and Jobs Act, the maximum bonus depreciation deduction was limited to 50% of the cost of qualified property. Then, from 2018-2022, it jumped to 100%. As it stands now, we are posed to lose the 100% bonus depreciation deduction starting in 2023, when the deduction will be reduced to 80% of qualifying expenses. After 2023, the deduction will continue to decrease by increments of 20% every year until it hits 0%, meaning no bonus depreciation allowed in 2027. The constant changes in the maximum deduction allowed on a year-by-year basis underscore the importance of using tax planning in the coming years.

Some states, such as MN, do not allow bonus depreciation, causing complex calculations on each return. Of course, in Wyoming and South Dakota we have no such hassle, as we don’t have an income tax.

Please reach out to your tax advisor at Ketel Thorstenson to discuss bonus depreciation and your specific tax situation.