Being a small business owner can come with valuable tax breaks, but sometimes, navigating the complexity of small business taxes can be tricky. One tax deduction that can be particularly confusing is bonus depreciation. In this guide, we’ll cover the ins and outs of bonus depreciation to help you understand this deduction better and ultimately make more informed decisions for your business.
At a glance:
- Bonus depreciation lets businesses deduct a fixed percentage of an asset’s cost upfront, reducing taxable income.
- Only certain types of qualified property are eligible for bonus depreciation.
- There are important differences between bonus depreciation and Section 179. Sometimes, you can take both deductions in the same year.
What is bonus depreciation for a business?
Bonus depreciation is an accelerated form of depreciation — it allows you to deduct a fixed percentage (80% for 2023) of an asset’s cost upfront instead of spreading the deduction out over its useful life. This tax strategy lowers taxable income and can help reduce tax liability.
For example, if you bought a qualified asset worth $100,000 in 2023, you could deduct $80,000 (80%) in bonus depreciation the first year instead of spreading the cost over multiple tax years.
Is bonus depreciation the same as Section 179?
Many first-time small business owners confuse two common forms of depreciation: bonus depreciation and the Section 179 deduction. While they may seem similar on the surface, these two depreciation methods are quite different, and each has its own restrictions.
Section 179 allows you to deduct a set dollar amount instead of a fixed percentage when using bonus depreciation. Under Section 179, you can write off the entire cost of an asset (up to $1,160,000 in 2023) as an immediate business expense on your tax return. This deduction starts to phase out if you spend more than $2,890,000 in 2023.
In contrast, bonus depreciation has no cost limit — it can even exceed your business income, creating a net loss. This differs from Section 179, which does not allow you to deduct more than you made. Creating a net loss allows you to carry that loss forward to offset income you make in future tax years.
In certain instances, you may be able to claim both bonus depreciation and Section 179 in the same year, but you must take Section 179 deductions first before taking bonus depreciation. For example, you can deduct a cost up to the annual limit with Section 179 and use bonus depreciation for the rest.
What are the rules for bonus depreciation in 2023 and 2024?
Before Congress passed the Tax Cuts and Jobs Act (TCJA) of 2017, bonus depreciation rules were much different. After TCJA was passed, businesses could immediately write off 100% of the cost of “qualified business property” if purchased and placed in service after Sept. 27, 2017, and before Jan. 1, 2023.
However, as of tax year 2023, bonus depreciation was reduced to 80%. The allowable percentage is set to decrease in 20% increments every year through 2027, meaning bonus depreciation is set at 60% for 2024, 40% for 2025, and 20% for 2026 until the current provision expires and drops to 0% in 2027.
To qualify for bonus depreciation, you must meet specific criteria set by the IRS. Only purchases of eligible assets qualify for bonus depreciation. Here are some rules to keep in mind and examples of qualifying property:
- Useful life: To qualify for bonus depreciation, the asset must have a useful life of 20 years or less. For example, a building wouldn’t be eligible for bonus depreciation, but a vehicle or piece of equipment would be.
- Listed property: This type of asset can be used for business and personal purposes. For instance, if you’re a professional photographer using your camera for personal use, you must use the item for business purposes at least 50% of the time to qualify for bonus depreciation.
- Qualified improvement property: This includes improvements made to the interior of a commercial (nonresidential) building, as long as the improvements were made after the building opened for business.
- Short-term rentals: This includes vacation rental properties where the average stay is seven days or less.
- Other costs: The cost of computer software and certain film, TV, and live theatrical productions can also qualify for bonus depreciation.
You can only claim bonus depreciation for the year you placed the asset in service (started using it). If you’re unsure whether a business asset qualifies for bonus depreciation, the IRS has a detailed FAQ page that can help.
Should I take bonus depreciation, or is it better to take Section 179?
Whether you should take the bonus depreciation or Section 179 deduction depends entirely on your tax situation.
Now that bonus depreciation is no longer 100%, Section 179 may be a better option if your business is profitable and you are below the annual limit. Section 179 offers more flexibility, allowing you to choose how much of the asset you want to deduct and when, while bonus depreciation is limited to a set percentage (80% in 2023 and 60% in 2024). However, Section 179 cannot create a net loss like bonus depreciation can. If your business was not profitable during the year, bonus depreciation may allow you to still write off a business asset, even if its cost exceeds your business income.
Both options can be valuable tax write-offs under the right circumstances. If you’re unsure which deduction is best for you, it may be wise to consult a tax professional.
How do I report bonus depreciation on my tax return?
To claim bonus depreciation on your income tax return, you’ll need to fill out IRS Form 4562, Depreciation and Amortization. To make the tax filing process easier, TaxAct® can help you claim the bonus depreciation deduction when you file with us.
The bottom line
Bonus depreciation and Section 179 can both be valuable tax benefits for small business taxpayers. The key to making them work for you is understanding their differences and the unique advantages each offers based on your business’s needs. But remember, tax laws and regulations can change, and staying informed is crucial to making the right financial decisions and optimizing any tax-saving opportunities for your business. When you file your small business taxes with us at TaxAct, our software will walk you through a broad range of business expenses and situations to help identify the deductions that apply to your situation.