Fixed assets such as equipment, machinery, software, computers and vehicles help small businesses operate efficiently and generate income. In addition, fixed assets give small businesses a nice bonus when they file their income taxes. We are referring to bonus depreciation, which is a tax incentive that allows small businesses to write off a specific percentage of the purchase price of eligible assets and property. If you do not fully understand what bonus depreciation is or how it works, this blog post from Balboa Capital is for you. It has all of the information you need to know about bonus depreciation.
Origins of bonus depreciation.
The year was 2002, and the United States was rebounding from a slight recession that began in 2001. To help boost the economy and increase business spending, Congress introduced the Job Creation and Worker Assistance Act, which included a new tax incentive called bonus depreciation. Small business owners who elected to use bonus depreciation were able to write off 30% of the cost of certain qualifying assets. Bonus depreciation was an instant hit with small business owners, and our government took notice and increased the bonus depreciation rate to 50% in 2003.
Over the years, bonus depreciation rules and rates have gone through a number of changes. For example, qualifying assets needed to be purchased and placed into business service during specific time frames in order to be eligible for bonus depreciation. When new economic stimulus packages were introduced, such as the Protecting Americans from Tax Hikes (PATH) Act or the Tax Cuts and Jobs Act, the bonus depreciation percentage rates were revised.
In 2017, the Tax Cuts and Jobs Act doubled the first-year bonus depreciation rate from 50% to 100% for eligible property that is acquired and placed into service from September 28, 2017 to December 31, 2020. Please note the more-generous 100% limit is scheduled to phase down starting in 2023. This graph shows you what the bonus depreciation rates will be in the years ahead.
|Scheduled bonus depreciation rate by year|
|Assets placed into service in calendar-year 2023||80%|
|Assets placed into service in calendar-year 2024||60%|
|Assets placed into service in calendar-year 2025||40%|
|Assets placed into service in calendar-year 2026||20%|
How bonus depreciation works.
Bonus depreciation is basically an accelerated depreciation that lowers your tax burden. Instead of spreading out the purchase price of a qualifying asset over many years, bonus depreciation lets you deduct up to 100% of the purchase price in the year you buy it and start using it. Keep in mind that the bonus depreciation rates will change in 2023, as indicated in the graph above. Bonus depreciation is available for many types of new and used assets and property that have a useful life of two decades or less. This includes machinery, vehicles, equipment, computers, printers, furniture and off-the-shelf software.
Here is a sample scenario of how bonus depreciation works. A construction company lands a contract to build homes in a new master-planned community. After reviewing the size and scope of the project, the construction company’s CEO decides to purchase $200,000 worth of heavy equipment in 2020, the same year in which the construction job started. The equipment qualifies because it has a depreciation period of 20 years or less, and it was put into service in the year it was acquired. The first-year bonus depreciation rate is 100% in 2020 and, as a result, the construction company’s CEO will be able to deduct the entire $200,000 on his 2020 tax return.
Bonus depreciation and Section 179.
Many small business owners confuse bonus depreciation with the Section 179 tax deduction. That is because both of these tax incentives offer similar benefits, and they can be used together. In a nutshell, bonus depreciation lets you recover the cost of eligible assets or property you buy, while Section 179 lets you expense the cost. Bonus depreciation is a good option if your asset purchases will exceed the current Section 179 limit. If you take both the Section 179 and bonus depreciation allowances, the Section 179 deduction needs to be used first, and the amount that surpasses the Section 179 limit can be taken in bonus depreciation.
With all of the variables and rules that are involved with bonus depreciation, understanding how it works can be quite difficult. That is why you should consult with your accountant or business attorney prior to purchasing assets or property, or taking the bonus depreciation deduction. We hope you found this information to be helpful.