Bonus depreciation

Definition

Bonus depreciation is a tax incentive that allows businesses to immediately deduct a significant percentage of the purchase price of qualifying assets, such as machinery and equipment, in the year the asset is placed in service. This accelerated depreciation method aims to encourage investment by providing immediate tax relief, which can significantly impact cash flow and financial planning.

5 Must Know Facts For Your Next Test

1. Bonus depreciation allows businesses to deduct 100% of the cost of qualifying assets in the year they are placed in service, under the Tax Cuts and Jobs Act until 2022.
2. After 2022, bonus depreciation phases down by 20% each year until it reaches zero in 2027, unless further legislative changes occur.
3. This tax benefit is available for both new and used property, as long as the property was not previously owned by the taxpayer.
4. Bonus depreciation can create substantial tax savings, improving cash flow for businesses in their investment decisions.
5. Certain types of property, such as land and buildings, generally do not qualify for bonus depreciation but may be eligible for standard depreciation methods.

Review Questions

• How does bonus depreciation differ from standard depreciation methods when it comes to tax benefits for businesses?
  • Bonus depreciation provides a more immediate tax benefit compared to standard depreciation methods. While standard depreciation spreads out the deduction over several years based on the asset's useful life, bonus depreciation allows businesses to deduct a significant percentage—up to 100%—of the asset's cost in the first year it is placed in service. This can greatly enhance cash flow and incentivize capital investments more aggressively than traditional methods.
• Evaluate the potential impact of bonus depreciation on a business's financial strategy and investment decisions.
  • Bonus depreciation can significantly influence a business's financial strategy by providing immediate tax savings that can be reinvested into operations or expansion. The ability to deduct a large portion of an asset's cost upfront encourages companies to invest in new equipment and technology. However, businesses must also consider their overall tax situation and future earnings when leveraging this deduction to ensure they are making sound financial decisions.
• Assess how changes in legislation regarding bonus depreciation might affect market trends in capital investments across various industries.
  • Changes in legislation surrounding bonus depreciation can have profound effects on market trends in capital investments. For example, an extension of 100% bonus depreciation incentivizes companies to invest heavily in upgrading equipment and technology, potentially boosting sectors like manufacturing and construction. Conversely, a reduction or elimination of bonus depreciation may lead to a slowdown in capital expenditures as businesses reassess their investment strategies. Understanding these legislative impacts can help investors gauge industry performance and forecast economic conditions.

Related terms

Section 179: A tax code provision that allows businesses to deduct the full purchase price of qualifying equipment and software purchased or financed during the tax year.

Depreciation:

The accounting method used to allocate the cost of a tangible asset over its useful life, reflecting wear and tear, deterioration, or obsolescence.

Qualified Property: Property that meets specific criteria set forth by the IRS, making it eligible for bonus depreciation, typically including new or used tangible property placed in service during the year.