Wouldn’t you love to receive a bonus whenever you buy a fixed asset for your business? Well, as impossible as that sounds, that’s what bonus depreciation actually does.
As you know, every time your business acquires a piece of new equipment, depreciation allows you to write off its cost throughout the number of years it will be used for business operations. But bonus depreciation allows you to deduct a higher percentage of its cost in the same year it was purchased instead of overtime – granted that it’s eligible for the terms of this program.
Doesn’t it sound enticing? If you want to know how to maximize the perks of bonus depreciation, below is a quick guide to help you understand.
Who qualifies for bonus depreciation?
Bonus depreciation was originally created to aid small businesses to invest in properties and equipment in their first year to promote the growth of the economy. But now, any business can qualify for this deduction, depending on the type of asset you purchase and when it was acquired.
Bonus depreciation is mandatory once a business has a qualifying asset unless you choose to elect out.
How does bonus depreciation work?
To maximize bonus depreciation, you must purchase a qualified property or equipment that’s used for income-generating activities and has a limited useful life.
Once you acquire these, place them in service immediately so you can write off 100% of their cost in the same year. If you delay the use of your asset within the tax year, you’ll have to wait for the next tax year to claim your bonus depreciation, where your property may have already depreciated in value.
To claim your bonus depreciation, fill out Form 4562 indicating your assets, and file it along with your business tax return.
What qualifies for bonus depreciation?
Before you close the deal on a certain asset that you’ve been eyeing, make sure it qualifies for one or more of the following criteria:
- Property that has a maximum useful lifespan of 20 years or less. Land and buildings are excluded since they can be used for more than 20 years.
- Qualified improvement property that enhances the interior of nonresidential real property (or commercial building).
- Computer software.
- Listed properties that are used for personal and business use at least 50% of the time, i.e. cameras or vehicles.
- The qualified film, television, or live theater productions.
Keep in mind that there might be different bonus depreciation limits for vehicles, depending on their type and size. This is to prevent business owners from claiming large tax deductions on luxury cars or for vehicles that are mostly for personal use.
The only exception is if your vehicle has a gross vehicle weight (GVW) rating of above 6,000 pounds that’s used for business purposes more than 50% of the time, that’s when you can claim 100% of its cost.
Bonus depreciation phase-out
Due to the Tax Cuts and Jobs Act of 2017 (TCJA), businesses are able to write off 100% of the cost of qualified new assets, and 50% of the cost of used ones. But for the next 4 years, it’s slowly phased out by 20% for each year, applying to both new and used business properties. So the tax deduction rate for the next years will be:
- The tax year 2023: Bonus depreciation rate is 80%
- The tax year 2024: Bonus depreciation rate is 60%
- The tax year 2025: Bonus depreciation rate is 40%
- The tax year 2026: Bonus depreciation rate is 20%
- The Tax years 2027 & later: Bonus depreciation rate is 0%
Bonus depreciation was created as a short-term solution to encourage small businesses to invest in properties and assets. Although this phase-out is considered permanent, it could still be reinstituted in future legislation.
Can you elect out of bonus depreciation?
As beneficial as bonus depreciation can be for your business, you still have the choice to elect out of it for various reasons, including whether you want to have a more stable tax return or your accountant advises against it.
If you choose to opt-out, you just need to attach a statement on your business tax returns. But do note that you have to opt out of each of your assets separately. The election will apply to all of your assets that are placed in service within the same tax year and will be deemed non-qualifying.
If you decide to revoke the election, you’ll have to obtain a letter ruling since you’ll need the consent of the commissioner of the Internal Revenue Service (IRS). Although there is an automatic extension of 6 months from the due date of your business tax return where you can file an amended tax return to revoke your election out of bonus depreciation on your properties.
Have an accounting question?
If you have further questions or are seeking legal advice on how to maximize bonus depreciation for your business, don’t hesitate to reach out to Lear & Pannepacker.
They have a team of professional accountants and advisers that can assist you with any of your financial and tax planning challenges. So contact their team now to connect with an accountant