As a business owner, you are likely aware of the many tax deductions and credits available to help reduce your tax burden. However, you may not be familiar with bonus depreciation, a valuable tool that can help you save even more money on your taxes.
In this article, we’ll explain what bonus depreciation is, how it works, and provide some examples to help you better understand how it can benefit your business.
What is Bonus Depreciation?
Bonus depreciation is a tax incentive that allows businesses to immediately deduct a percentage of the cost of qualified property from their taxable income. This percentage is in addition to the regular depreciation deduction that businesses can take over the useful life of the property.
The Tax Cuts and Jobs Act (TCJA) of 2017 expanded the availability and scope of bonus depreciation. The act allows businesses to immediately deduct 100% of the cost of qualified property that was acquired and placed in service between September 27, 2017, and January 1, 2023. This is up from the previous limit of 50% for qualified property placed in service before September 27, 2017.
Qualified property includes tangible property with a recovery period of 20 years or less, such as machinery, equipment, furniture, and fixtures. It also includes certain qualified improvement property, such as improvements to the interior of nonresidential real property. However, it’s important to note that certain types of property are excluded from bonus depreciation, such as used property and property used predominantly outside of the United States.
How Bonus Depreciation Works
Let’s say you purchase $50,000 worth of qualified equipment for your business in 2022. Under normal depreciation rules, you would have to spread the $50,000 over the useful life of the equipment and deduct a portion of the cost each year. However, with bonus depreciation, you can deduct the entire $50,000 in the year the equipment was placed in service.
Here’s how the math works out:
Cost of equipment: $50,000
Bonus depreciation percentage: 100%
Bonus depreciation deduction: $50,000
Regular depreciation percentage: 20%
Regular depreciation deduction: $10,000
Total deduction in first year: $60,000
As you can see, bonus depreciation can have a significant impact on your tax savings. By taking advantage of bonus depreciation, you can accelerate your tax deductions and reduce your taxable income in the year the property is placed in service.
Examples of Bonus Depreciation
To better understand how bonus depreciation works in practice, let’s look at a few examples:
Example 1: Manufacturing Business
A manufacturing business purchases $500,000 worth of new equipment in 2022. The equipment has a recovery period of 10 years and is placed in service in the same year. Under normal depreciation rules, the business would be able to deduct $50,000 per year for 10 years. However, with bonus depreciation, the business can immediately deduct the entire $500,000 in 2022.
Example 2: Restaurant Business
A restaurant business spends $200,000 on improvements to the interior of a nonresidential property in 2022. These improvements have a recovery period of 15 years and are placed in service in the same year. Under normal depreciation rules, the business would be able to deduct $13,333 per year for 15 years. However, with bonus depreciation, the business can immediately deduct the entire $200,000 in 2022.
Example 3: Real Estate Business
A real estate business purchases a building for $1 million in 2022. The building has a recovery period of 39 years and is placed in service in the same year. Under normal depreciation rules, the business would be able to deduct a portion of the cost of the building each year for 39 years. However, with bonus depreciation, the business can immediately deduct 100% of the cost of any qualified improvement property included in the building. For example, if the business spends $100,000 on improvements to the interior of the building, it can deduct the entire $100,000 in 2022.
How Bonus Depreciation Affects Your Business
Taking advantage of bonus depreciation can have a significant impact on your business’s bottom line. By accelerating your tax deductions, you can reduce your taxable income in the year the property is placed in service, which can help you save money on your taxes and improve your cash flow.
Bonus depreciation can also make it more affordable for businesses to invest in new equipment and property. By allowing businesses to immediately deduct a percentage of the cost, bonus depreciation can make the purchase of new equipment and property more financially feasible, which can help businesses stay competitive and grow.
However, it’s important to note that bonus depreciation is not always the best option for every business. Depending on your specific tax situation, it may be more advantageous to spread the cost of the property over the useful life of the property using regular depreciation.
Additionally, bonus depreciation may not always be available. The current 100% bonus depreciation rate is only available for property placed in service between September 27, 2017, and January 1, 2023. After that, the bonus depreciation rate will be reduced over the following several years until it reaches 0%.
Bonus depreciation can be a valuable tool for businesses looking to reduce their tax burden and improve their cash flow. By immediately deducting a percentage of the cost of qualified property, businesses can accelerate their tax deductions and save money on their taxes. However, it’s important to understand the specific rules and limitations of bonus depreciation, as it may not always be the best option for every business.
As with any tax-related decision, it’s always a good idea to consult with a tax professional before making any decisions. A tax professional can help you determine whether bonus depreciation is the right choice for your business and provide guidance on how to take advantage of the tax benefits available to you.