The 2022 tax year is the final chance for businesses to take advantage of 100% bonus depreciation under the Tax Cuts and Jobs Act of 2017 (TCJA). Bonus depreciation is a tax-savings strategy that allows businesses to deduct a certain percentage of the cost of an asset in the first year it is placed in service. This accelerates the process of regular depreciation by allowing the business to deduct a higher amount sooner.
The TCJA extended bonus depreciation through 2026 and expanded the benefit to allow for 100% bonus depreciation for long-term assets placed in service after September 27, 2017 and before January 1, 2023. This amount begins to phase out in 2023, before sunsetting entirely in 2027.
Bonus depreciation amounts are scheduled to decrease as follows:
- Property placed in service after December 31, 2022 and before January 1, 2024: 80% of the asset’s cost
- Property placed in service after December 31, 2023 and before January 1, 2025: 60% of the asset’s cost
- Property placed in service after December 31, 2024 and before January 1, 2026: 40% of the asset’s cost
- Property placed in service after December 31, 2025 and before January 1, 2027: 20% of the asset’s cost
Now is the time to evaluate your tax-savings strategies and purchasing decisions for the 2022 tax year to determine if bonus depreciation is the best option for your business. Maximizing the value of this tax strategy comes by understanding the rules and requirements under current tax law, such as:
What assets qualify for bonus depreciation?
Another significant change made by the TCJA is the applicability of bonus depreciation to used assets, not only new ones, beginning in 2018. Excluding real property, virtually any type of new or used tangible personal business property qualifies for bonus depreciation if it has a useful life of 20 years or less and is purchased from a non-relative.
Certain “listed assets” need to be used for business more than 50% of the time in order to qualify for bonus depreciation. This includes passenger automobiles and other vehicles, photography and videography equipment, and other assets that could potentially be used for non-business purposes. The TCJA removed computers from this category, and they no longer need to meet the 50% rule.
What does “placed in service” mean?
Bonus depreciation requires the property to be “placed in service” in the year the deduction is taken. The asset does not need to be used during that first year, as long as it is available to your business for its designated purpose. For example, if machinery is installed within your business but is not used, it is still available and eligible for bonus depreciation. If the machinery is purchased but not installed, the deduction cannot be taken in that tax year.
How does bonus depreciation compare to other depreciation methods?
Depreciation of assets is required, but bonus depreciation is optional. Bonus depreciation, especially at 100%, is typically more advantageous than other depreciation methods, such as regular depreciation and Section 179 expensing, which allow for smaller deductions over time.
First-year bonus depreciation results in a much higher deduction, reducing your overall taxable income more significantly. After bonus depreciation, the remaining cost of the asset can be deducted over several years through regular depreciation or Section 179 expensing.
In addition to the higher first-year deduction, bonus depreciation has other advantages over other methods, including:
- No annual dollar limit. Section 179 expensing is limited to $1.08 million for 2022.
- The full deduction can be taken, no matter when the asset was purchased. Under regular depreciation, the deduction is reduced when the asset is purchased late in the year.
- Can be used to create a net loss. Section 179 is limited to the amount of taxable income.
However, 100% bonus depreciation does mean you are giving up the benefit of depreciation in subsequent years. It also lowers the value of your assets, potentially affecting balance sheet ratios that determine your borrowing potential. Sales of assets that have received first-year depreciation may also trigger tax on the gain.
Deciding which depreciation method(s) is the right one for your business in any given tax year should be done in close consultation with your tax advisor. When determining which method to use for federal purposes, be sure to consider the state in which the asset is placed in service. Most states have their own respective rules regarding all types of depreciation, and this could influence the federal method you choose.
