What Is Bonus Depreciation and How Do You Calculate It?

As the owner and founder of a business, you’ve likely found that there are several ways to reduce your overall tax burden. Of course, if you want to take advantage of those options, you and your accountant (or accounting team) will need to make wise decisions when tax time comes around.

The most savvy business owners and accounting teams look for various ways to write off income, ultimately reducing their tax burdens and potentially saving money.

One way to do so is through bonus depreciation. You see, depreciation and taxes go hand in hand. And, in the United States, companies are typically able to write the depreciation of their assets off, leading to a lower tax burden. But, bonus depreciation takes things a step further, especially in the first year of owning a new business asset.

So, what exactly is bonus depreciation and how can you use it to reduce your overall tax burden? Read on to find out.

Bonus Depreciation 101

The bonus depreciation rule, also known as the first-year depreciation deduction or the 168(k) allowance, gives businesses a way to write off a meaningful percentage of a new business asset’s cost in the first year of ownership.

If you’re familiar with the 179 deduction or 179 depreciation, this may sound familiar. However, the bonus depreciation deduction is somewhat different from the 179 deduction. The difference is in how these deductions are calculated. While the bonus depreciation deduction is calculated as a percentage of the value of the asset, the 179 depreciation offers write-offs of a set dollar amount.

Bonus Depreciation Definition

Bonus depreciation is a bonus taxation tool that gives business owners a way to write off a percentage of the cost of new business assets. At least, that’s the case for a few more years to come (unless the United States tax code changes).

There are a few bonus depreciation rules that you’ll need to keep in mind if you plan on taking advantage of this tax deduction. First, the deduction only applies to qualified property (we’ll outline what that means shortly). Moreover, this deduction is dependent on the purchase price of the asset. So, you’ll need to be able to prove that price. Finally, you’ll have to use the IRS depreciation schedules when determining your write-off percentage. The amount you can write off will be reduced each year.

In 2024, you can deduct 60% of the cost of new assets. However, that percentage will fall by 20% each year until 2027, when the cap on bonus depreciation will be 0%, phasing this deduction out.

Eligibility Criteria

Only depreciable assets are considered eligible assets under the bonus depreciation deduction. Some examples of depreciable assets include:

• Modified Accelerated Cost Recovery Systems: This includes items like office furniture and computers. These assets must have a recovery period of 20 years or less to qualify.
• Real Property: Though you can include real property, you’ll need to have a cost segregation study done to ensure it qualifies as eligible property.
• Qualified Film and Other Productions: This includes the cost of production for film, television, and other theatrical assets.  
• Vehicles: Only vehicles with a useful life of 20 years or less qualify.  
• Qualified Property Improvement: For example, the cost of remodeling a non-residential property may qualify for bonus depreciation.  

Consider going through your accounts payable to determine which assets you’ve purchased that may qualify for this deduction and tracking these assets when you close your books each month.

Impact on Business Taxation

The primary benefit of bonus depreciation is the reduction of your tax burden. With this bonus withholding, you may be able to make a significant difference in your business’s taxable income. Doing so obviously comes with tax benefits.

After all, if you’re able to reduce your taxable income, you’ll ultimately reduce your tax liability. In fact, in some cases, bonus depreciation can turn an operating profit into an operating loss, reducing your tax liability for the current year and potentially offering deductions that follow through for years to come. So, the impact of bonus depreciation on your business can be significant.

How To Calculate It

IRS bonus depreciation is much easier to calculate than other forms of depreciation. As mentioned above, unlike the 179 deduction, bonus depreciation is calculated as a percentage of the total purchase price of the asset, and that percentage is reduced each tax year. Here’s the breakdown of how to calculate your bonus depreciation:

Identify the Bonus Depreciation Rate

You’ll need to identify your bonus depreciation rate before you can calculate your deduction. The good news is that doing so is easy. It all depends on the year in which you purchased the asset. Items purchased from September 27, 2017, through December 31, 2022, have a 100% bonus depreciation rate. If you purchased the asset in 2023, you’ll have an 80% bonus depreciation rate. For 2024 and subsequent years, the bonus depreciation rates are as follows:

• Items purchased in 2024 have a 60% bonus depreciation rate.
• Items purchased in 2025 have a 40% bonus depreciation rate.
• Items purchased in 2026 have a 20% bonus depreciation rate.

Finally, unless the rules surrounding bonus depreciation change between now and 2027, this additional deduction will phase out in 2027 with the bonus depreciation percentage for that year being 0%.

Multiply the Bonus Depreciation Rate by the Cost of the Asset

Once you know your bonus depreciation rate, you simply need to multiply the purchase price of the asset by your rate to determine your deduction.

For example, say you spent $150,000 on a depreciable asset in 2023. Your bonus depreciation rate would be 80%. So, you would simply multiply $150,000 by 80%, giving you a bonus depreciation deduction of $120,000.

On the other hand, if you purchased that same asset in 2024, your bonus depreciation rate would be 60%. So, multiplying the asset value by 60% would give you a bonus depreciation deduction of $90,000.

Leverage Bonus Depreciation for Tax Advantages

Recovered depreciation through the bonus depreciation rule can have a significant impact on your tax liability.

 If you have purchased depreciable assets for your business at any point since September 27, 2017, you should strongly consider taking advantage of this bonus depreciation deduction as a way to reduce your overall tax burden. Keep in mind that this deduction will phase out in 2027 unless the rules change. So, take advantage of it now while you still can.

To learn more about bonus depreciation, get in touch with a tax advisor. 

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