What Is Bonus Depreciation?
Bonus depreciation is a tax incentive that allows businesses to immediately deduct a significant portion of the purchase price of eligible business assets in the year they are placed in service, rather than spreading the deductions over the asset's useful life through traditional depreciation schedules. This accelerated deduction reduces a company's taxable income and, consequently, its tax liability in the initial year of the asset's acquisition. As a component of Taxation policy, bonus depreciation is designed to encourage business investment and stimulate economic activity by improving a company's cash flow.
History and Origin
Bonus depreciation was first introduced in the United States through the Job Creation and Worker Assistance Act of 2002, initially allowing a 30% deduction for qualified property as an economic stimulus measure49, 50. Over the years, the percentage and rules for bonus depreciation have been adjusted by various legislative acts, often in response to economic conditions. For instance, the Jobs and Growth Tax Relief Reconciliation Act of 2003 increased the rate to 50%, and the Economic Stimulus Act of 2008 also featured a 50% rate48. A significant change occurred with the Tax Cuts and Jobs Act (TCJA) of 2017, which temporarily increased the bonus depreciation rate to 100% for qualifying property acquired and placed in service after September 27, 2017, and before January 1, 202347. This act also expanded eligibility to include certain used property, a departure from previous rules that typically limited it to new property45, 46. Since then, the 100% rate has begun to phase down, with the rate decreasing by 20% each year until it reaches zero in 2027, unless further legislative action is taken43, 44.
Key Takeaways
- Bonus depreciation is an accelerated tax deduction allowing businesses to write off a large portion of eligible asset costs in the first year.
- It functions as a tax incentive designed to stimulate capital investment and boost the economy.
- The percentage of the deduction has varied over time and is currently phasing out from 100%.
- Qualifying property generally includes new and certain used tangible property with a Modified Accelerated Cost Recovery System (MACRS) recovery period of 20 years or less41, 42.
- Businesses report bonus depreciation on IRS Form 456240.
Formula and Calculation
The calculation for bonus depreciation is straightforward, involving applying the applicable bonus depreciation rate to the original cost basis of the qualified asset.
For a given qualified asset:
The applicable bonus depreciation rate depends on the year the property is placed in service. For example, for property placed in service in 2023, the rate was 80%; for 2024, it is 60%; and for 2025, it is 40%39.
Interpreting the Bonus Depreciation
Interpreting bonus depreciation primarily involves understanding its impact on a company's immediate financial position and long-term investment strategies. A larger bonus depreciation deduction means a greater reduction in current-year taxable income, leading to lower taxes paid in that year. This upfront tax saving can significantly improve a business's cash flow and potentially create a net operating loss (NOL) that can be carried forward or back to offset income in other years38. From an economic perspective, lawmakers use bonus depreciation as a fiscal policy tool to incentivize businesses to make capital expenditures sooner rather than later, especially during periods when economic growth needs stimulation37.
Hypothetical Example
Consider "Tech Innovations Inc." which, in 2025, purchases a new machine for its manufacturing process costing $500,000. This machine qualifies for bonus depreciation. According to the current schedule, the bonus depreciation rate for property placed in service in 2025 is 40%36.
-
Calculate Bonus Depreciation:
Bonus Depreciation = $500,000 (Asset Cost) × 40% (2025 Rate) = $200,000 -
Remaining Basis for Regular Depreciation:
After taking bonus depreciation, the remaining depreciable basis of the machine is:
$500,000 - $200,000 = $300,000
This remaining $300,000 will then be depreciated over the machine's MACRS useful life using standard depreciation methods. The $200,000 bonus depreciation deduction immediately reduces Tech Innovations Inc.'s taxable income by that amount in 2025, providing a significant upfront tax benefit.
Practical Applications
Bonus depreciation is a powerful tool in tax planning and corporate finance, widely applied across various industries. Businesses utilize it to reduce their tax liability in the year they acquire qualifying assets, which can free up capital for other operational needs, expansion, or debt reduction.35 It is particularly relevant for companies making substantial capital expenditures on equipment, machinery, and certain software. The Internal Revenue Service (IRS) provides detailed guidance on claiming this deduction, typically requiring businesses to file Form 4562, "Depreciation and Amortization".34 From a broader perspective, governments implement bonus depreciation as a form of fiscal policy to incentivize business investment and stimulate economic growth, especially during downturns.33 For example, studies have indicated that past instances of bonus depreciation have boosted capital accumulation and employment opportunities.32
Limitations and Criticisms
While beneficial for businesses, bonus depreciation has faced limitations and criticisms. One significant limitation is that not all property qualifies; for instance, land, permanent structures attached to land (with some exceptions), inventory, and intangible property like patents are generally excluded.31 Furthermore, the deduction is only available in the year the property is placed in service.30
Critics often argue about the effectiveness of bonus depreciation as a short-term stimulus versus its long-term impact. Some studies and analyses suggest that while it can induce firms to accelerate purchases, its overall effectiveness as an economic stimulus tool might be limited, especially if the policy is enacted retroactively or is perceived as a permanent measure.28, 29 There is debate whether it primarily encourages new investment or merely shifts the timing of pre-planned capital expenditures.26, 27 Another criticism highlights that by accelerating deductions, bonus depreciation can contribute to a lower, or even negative, effective tax rate for certain investments, which some view as an overly generous subsidy or a narrowing of the tax base.24, 25 Some researchers have questioned its impact on job creation and wages, suggesting that while it spurs capital investment, the direct benefits to employment and worker compensation may be less direct or harder to measure.23
Bonus Depreciation vs. Section 179 Deduction
Both bonus depreciation and the Section 179 deduction are accelerated depreciation methods that allow businesses to deduct the cost of qualifying assets in the year they are placed in service. However, key differences exist.
Feature | Bonus Depreciation | Section 179 Deduction |
---|---|---|
Amount | A fixed percentage of the asset's cost (e.g., 40% for 2025), with no maximum dollar limit on the deduction itself.22 | A maximum dollar amount that can be deducted (e.g., $1,220,000 for 2024), which phases out if a certain amount of property is placed in service during the year.21 |
Eligibility | Applies to new and certain used qualified property.20 Generally applies to MACRS property with a recovery period of 20 years or less.19 | Applies to new and used tangible personal property.18 Primarily for property used in an active trade or business.17 |
Taxable Income | Can create or increase a net operating loss, meaning the deduction can exceed a business's taxable income.15, 16 | Limited to the business's taxable income; it cannot create a net operating loss.14 |
Mandatory | Businesses can opt out of bonus depreciation for certain classes of property.12, 13 | Businesses can elect to take the Section 179 deduction. |
The primary point of confusion often arises because both provisions aim to accelerate deductions and reduce current-year tax liability. However, bonus depreciation is typically a percentage-based allowance with no upper limit, making it more impactful for very large capital expenditures, whereas Section 179 has a dollar limit and is tied to taxable income.
FAQs
What types of property qualify for bonus depreciation?
Generally, qualified property for bonus depreciation includes tangible property with a MACRS recovery period of 20 years or less, such as machinery, equipment, certain computer software, and qualified improvement property. Both new and certain used property can qualify.10, 11
Is bonus depreciation mandatory?
No, bonus depreciation is not mandatory. Businesses can elect to opt out of bonus depreciation for any class of property for any taxable year. This election is made by attaching a statement to Form 4562, "Depreciation and Amortization", by the due date of the tax return.8, 9
How does bonus depreciation affect a business's taxes?
Bonus depreciation reduces a business's current-year taxable income by allowing a larger immediate deduction for qualifying asset purchases. This results in a lower tax liability in the year the asset is placed in service, improving the company's cash flow.6, 7
Will bonus depreciation continue indefinitely?
The current bonus depreciation provision is scheduled to phase down annually and expire completely in 2027, meaning the percentage deduction will reduce to 0%.4, 5 While it has been extended multiple times in the past, its future continuation at significant percentages depends on legislative action.3
Can bonus depreciation create a loss for my business?
Yes, unlike the Section 179 deduction, bonus depreciation can create or increase a net operating loss (NOL) for a business. This means the deduction can exceed the business's income in the year the property is placed in service.1, 2