If you look at Donald Trump’s tax returns, you’ll see that he barely pays any taxes, and the reason is because of depreciation. When you buy a property, it loses value over a period of time and you can start claiming that as a loss each year. Residential properties depreciate over 27.5 years, while commercial properties depreciate over 39 years.
And, different parts of a property lose value over different periods of time. You can do a cost-segregation study, which takes a property and breaks it into its distinct components. For anything that depreciates in under 15 years, you can get 80% depreciated upfront.
This is known as bonus depreciation.
What is bonus depreciation?
Most businesses have physical assets that depreciate over its life (the number of years it will be used in the business) and you’re allowed to take a deduction on the amount of depreciation each year. For example, if you buy a machine that costs $30,000 that will be used for 15 years, you may be able to write off $2,000 per year for 15 years.
Bonus depreciation lets us front load that depreciation and take more of it upfront, in Year 1. Because of this, some people refer to it as the first-year depreciation deduction.
The Tax Cuts and Jobs Act now allows businesses to get a cost segregation study that breaks it out into different components.
Anything marked with a lifespan of 20 years and under, you can get 80% depreciated upfront in Year 1. This could be 20% to 30% of the purchase price, which in many case can be equivalent to your cash down payment.
For example, you purchase a building for a million dollars, and get a $200,000 to $300,000 tax deduction in year 1.
Or, back to the $30,000 machine example, we would be able to get a tax deduction of $24,000 all in year 1 rather than taking the $2,000 per year spread over 15 years.
What are the benefits of claiming bonus depreciation?
Bonus depreciation reduces your taxable income by the depreciation amount. For example, if you take a bonus depreciation of $80,000 from a $100,000 property in year 1, your taxable income gets reduced by $80,000. This is more impactful to your tax liabilities than taking yearly depreciations spread over the span of the asset’s useful life.
How to claim bonus depreciation
While taking a depreciation is required when you purchase depreciable assets, bonus depreciation is not mandatory.
If you do want to claim bonus depreciation on any assets, here are the steps you need to take.
Step 1: Determine eligibility
First, you need to determine if the property you purchased is eligible for bonus depreciation. Generally, this includes new or used property that has a useful life of 20 years or less, such as machinery, equipment, furniture, and computers and software. Certain improvements to interior parts of non-residential buildings after the building was placed in service are also eligible.
Step 2: Understand the applicable depreciation rate
The bonus depreciation percentage can vary based on the year the property was placed in service. The 80% rate for bonus depreciation is only for 2023. In future years, it will slow begin to phase down. In 2024, the rate will drop to 60%. In 2025, the rate will drop to 40%. In 2026, the rate will drop to 20%. And in 2027, it will phase out completely to 0%.
Step 3: Place the property in service
To claim bonus depreciation, the property must be placed in service during the tax year for which you are filing. “Placed in service” means that the property is ready and available for use in your business. For example, if you buy a piece of equipment in October of 2023 but don’t plan to use it until May of 2024, you must wait until May 2024 to claim bonus depreciation on the asset.
Step 4: Calculate the depreciation
Calculate the depreciation amount based on the cost of the asset and the applicable bonus depreciation percentage. For example, if you purchased equipment for $10,000 in 2023, you would be allowed to depreciate 80% of the cost ($8,000) in the first year.
Step 5: Complete the appropriate tax forms
Typically, bonus depreciations are reported on IRS Form 4562. This form is used to claim your deduction for depreciation and amortization, make the election under Section 179 to expense certain property, and provide information on the business/investment use of cars and other listed property. Submit Form 4562 along with your business tax return.
Step 6: Maintain records
Keep detailed records of the purchase date, cost, and use of the property. These records are essential for supporting your claim if the IRS has any questions or if you are audited.
What assets qualify for bonus depreciation?
- Modified Accelerated Cost Recovery System (MACRS) property with a useful lifespan of 20 years or less such as computer equipment and office furniture.
- Depreciable computer software
- Water utility property
- Costs of certain film, TV, and live theatrical productions
- Vacation properties used as a short-term rental unit
- Residential rental estate
- Vehicles that have a useful life of 20 years or less
Can software qualify for bonus depreciation?
Computer software can be depreciated if meets the following requirements:
- It is readily available for purchase by the general public.
- It is subject to a nonexclusive license.
- It has not been substantially modified.
Can used assets qualify for bonus depreciation?
Used assets can also qualify for bonus depreciation if it meets the following requirements:
- You did not use the property at any time before purchasing it.
- You didn’t purchase the property from a related party.
- You didn’t purchase the property as part of a tax-free transaction.
Can vehicles qualify for bonus depreciation?
Yes, you can claim bonus depreciation on vehicles but the rate depends on the type and size of the vehicle.
- Vehicles with a gross vehicle weight of 6,000 pounds of less are limited to $8,000 of bonus depreciation in the first year of service.
- Vehicles with a gross vehicle weight over 6,000 pounds that are used for more than 50% for business use can be deducted 80% of the cost.