A Guide to Bonus Depreciation

What is bonus depreciation?

Depreciation is a taxation strategy that allows a business to write off an asset’s fair market value or cost over its projected useful life (how long the company estimates the asset will be used for business purposes).

For example, say a moving company uses a large truck for its primary business activities. The truck was purchased for $100,000 and the owner estimated the company would use it for 10 years. That means the business can write off $10,000 worth of business expenses on their tax returns each year up until the 10-year limit.

That’s a significant write-off but not necessarily enough for most business owners. That’s where bonus depreciation comes in.

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Bonus depreciation lets business owners accelerate the depreciation process. Businesses can write off more than a single year’s cost of an asset in the same year they start using it. In the above example, the business owner could write off more than $10,000 in the year the truck is purchased.

The tax year will affect how much you can write off. According to the Tax Cuts and Jobs Act of 2017 (TCJA), businesses can write off up to 100 percent of the cost for any eligible assets or property purchased after Sept. 27, 2017, and before Jan. 1, 2023. Previously, business owners could write off only up to 50 percent of a given asset.

While this sounds great, the 100 percent write-off limit started to decrease after 2022 and will expire at the end of 2026 unless Congress extends it. The depreciation bonus rate will decrease as follows over the next few years:

• 2024: Max depreciation up to 60 percent
• 2025: Max depreciation up to 40 percent
• 2026: Max depreciation up to 20 percent

To recap, businesses can normally write off only one year’s cost of a given asset to get a better tax return. Bonus depreciation allows businesses to write off more than a single year’s cost of the asset instead. [Related article: What Are Tangible Assets?]

How does bonus depreciation work?

To take advantage of bonus depreciation, you must first determine if you have any qualified business property. If you do, you must start using the asset in the appropriate tax year.

For example, say the moving company described above purchased a new truck in December 2022. However, it didn’t plan to start using the truck until January 2023. In this case, the company would need to wait until filing its 2023 tax return to claim any bonus depreciation on the moving truck.

Next, the company must claim the bonus depreciation on its business taxes. It could claim up to 100 percent depreciation for the cost of the moving truck using Form 4562. This form is filed alongside the primary business tax return paperwork.

How do you qualify for bonus depreciation?

While bonus depreciation is technically available for every business owner, only certain types of property qualify. Consider the following qualifications and restrictions surrounding bonus depreciation. 

Qualifications

For your business to qualify for bonus depreciation, it must have business property that meets at least one of the following criteria:

• It has a maximum useful life of 20 years or less. Land and buildings are excluded since these assets could be used for much longer than 20 years.
• It’s a qualified improvement property, which covers properties that improve the interiors of nonresidential real properties or commercial buildings. 
• It is used for qualified film, television or live theater productions. 
• It can be used for both business and personal use, such as cameras and vehicles.

There are also multiple restrictions on how bonus depreciation can be used on vehicles. The IRS has different bonus depreciation limits for vehicles, so business owners can’t claim large tax deductions on cars that are primarily for personal use.

Another restriction

In addition to the above restrictions on listed property, you cannot use the entire bonus depreciation amount if you also use the Section 179 expense deduction, which allows your business to write off the cost of a specific qualified property right away. It serves a similar purpose as bonus depreciation, but it’s not the same.

For example, you can’t claim Section 179 unless you have a taxable profit to report. Say your business has just $10,000 in taxable income before taking the Section 179 deduction. From there, you decide to purchase $20,000 worth of machinery or equipment. Your Section 179 deduction is limited to $10,000. Then, you can either claim regular depreciation on the remaining $10,000 or carry the unused deduction into the next tax year.

Electing out of bonus depreciation

Although bonus depreciation can be helpful, some businesses may want to opt out. Here are a few reasons you may want to elect out of bonus depreciation:

• You want your tax returns to be more stable or consistent.
• You missed the window to depreciate 100 percent of the cost.
• Your accountant advises you not to take a bonus depreciation. 

You’re never forced to take bonus depreciation for assets and you can opt out by attaching a statement to your business tax returns. However, every owner must opt out of each bonus depreciation separately. In such circumstances, you may use modified accelerated cost recovery system depreciation methods or other strategies.

How to record bonus depreciation on your tax return

Recording or claiming the bonus depreciation for an asset on your tax return is simple. Just use IRS Form 4562, which allows you to record and review any bonus depreciation your business has taken.

This same form will be used to claim any other types of depreciation, like the Section 179 deduction. Review the full instructions for Form 4562 to ensure you don’t miss anything and that you calculate your bonus depreciation accurately.

Best accounting software for managing bonus depreciation

The right accounting software can help you keep track of bonus depreciation so you’re ready for tax season. Below are some of the best accounting software tools to help you manage and calculate depreciation:

• Intuit QuickBooks Online: This accounting software tool allows you to set up a dedicated depreciation account to easily monitor asset values over time. QuickBooks features dropdown fields specifically designed for creating journal entries, which help you accurately record asset depreciation and reflect their lost value in your statements. To learn more about this software and its built-in reporting features, check out our detailed QuickBooks Online review.
• Xero: Xero can help you easily calculate annual and monthly depreciation based on your preferred method, whether straight-line, declining balance or full depreciation on purchase. This software allows you to select specific assets from your accounting menu and run or roll back depreciation calculations as needed. This flexibility helps ensure you accurately manage your assets and report your finances. Our comprehensive Xero accounting software review highlights this platform’s numerous other features that can keep your asset management on track.
• Plooto: While Plooto isn’t a full-scale accounting solution, it excels in automating accounts payable and basic accounts receivable tasks. This software integrates seamlessly with platforms like QuickBooks and Xero, allowing a streamlined experience with error-free reconciliation and automatic updates. Our Plooto accounting software review explains how you can set up custom automation workflows to handle approvals and use timed payments to optimize cash flow, making it easier to manage depreciation schedules.
• Zoho Books: Zoho Books allows you to set up recurring journal entries that automatically repeat based on your chosen frequency. This way, your depreciation calculations are consistent and accurate. This platform also includes automated workflows to simplify expense tracking. Explore how this software can streamline your accounting processes in our Zoho Books accounting software review.
• FreshBooks: This software makes organizing and categorizing expenses a breeze. Its automated bank reconciliation feature ensures your financial data is always current, making it simpler to monitor depreciation over time. Plus, as our FreshBooks accounting software review explains, this platform comes stacked with robust reporting capabilities, so you can generate detailed accounting reports that allow for more accurate tax planning and financial forecasting. 

Maximizing your tax savings and asset value

Business owners can use bonus depreciation to lower their taxable income on their tax returns. Bonus depreciation can help you maximize the value of a newly purchased asset sooner rather than later. However, make sure to use bonus depreciation carefully and when it makes economic sense. You might want to consider using a small business accountant before leveraging bonus depreciation, especially across multiple assets.

Shayna Waltower contributed to this article.