Congress’ Job Creation and Worker Assistance Act of 2002 enacted a tax incentive that allows a taxpayer to expense the entire cost or a large percentage of the majority of fixed assets in the year that they were purchased and put in service. This tax incentive is known as bonus depreciation. In this article, we will discuss bonus depreciation examples with calculations to help you understand how this special depreciation deduction works.
Related: Adjusting Entry for Depreciation
Bonus depreciation explained
In business, you depreciate an asset over its useful life. This is necessary to reflect the time that is expected of an asset to generate revenue and be useful to the business. Usually, the entire depreciation expense of a fixed asset is spread over a period of years, but with bonus depreciation, the entire depreciation expense can be reported in the year of purchase.
Bonus depreciation is an accelerated depreciation method that allows taxpayers to report a larger percentage of depreciation in the year that the asset was bought and put in service. That is, by claiming bonus depreciation, you can deduct the cost of a fixed asset in the year that it was purchased and put to work. From 2017 through 2022, you can deduct up to 100% of the purchase price of an asset in the year of purchase on your business taxes.
This deductible percentage rate was increased in 2017 from 50% of an eligible asset’s cost to 100% by the Tax Cuts and Jobs Act of 2017 (TCJA). Nonetheless, after 2022, the 100% rate decreases by 20 percent each year until it reaches 0% in 2027. This means that any property purchased between September 27, 2017, and January 1, 2023, is subject to the 100% bonus depreciation; but starting in 2023, the bonus depreciation rate drops down. That is:
- 80% for 2023
- 60% for 2024
- 40% for 2025
- 20% for 2026
- 0% for 2027
See also: Is accumulated depreciation a fixed asset?
Bonus depreciation examples of how it works
In order to claim bonus depreciation there are compulsory procedures you will need to take. First of all, you need to purchase an asset that qualifies for bonus depreciation and then put the asset to good use. Then, you calculate and estimate the amount of bonus depreciation. The bonus depreciation amount is calculated using the year’s bonus depreciation rate. For instance, calculations for 2022 will be a bonus depreciation rate of 100% while calculations for 2023 will be a bonus rate of 80%.
After the amount has been estimated, you would have to fill out Form 4562 to report bonus depreciation on line 14 of the form. You enter the total amount of bonus depreciation you’re claiming and then submit your tax return for your business. In order to understand how bonus depreciation works, let’s say a coffee shop got an espresso machine for $8,000. By claiming bonus depreciation on the machine, the shop can report the entire $8,000 on its income statement and business tax return in the year that it bought the machine and started using it; instead of reporting $800 in depreciation annually for 10 years.
Another example of bonus depreciation would be a company that purchases a camera from the market. Let’s assume the owner of this business is a YouTuber and he bought the camera for $10,000. It is a professional camera, and the company has also customized it according to its preferences. According to the bonus depreciation rules, this camera will come under the category of qualified assets because it will be used in the company’s business.
However, in order to claim the bonus depreciation on the camera, it should have been used in the business at least 50% of the time. On claiming 100% bonus depreciation, this business owner can take a deductible value of $10,000 in the very first year that the camera is put to use if the year falls between 2017 to 2022.
Let’s take another bonus depreciation example; assume Mr. Peter purchased a new computer software in December 2022 for his business, but didn’t make use of the software until January 2023. With the way bonus depreciation works, he would have to wait until he filed his 2023 tax return to be able to take bonus depreciation on the software. Since the bonus depreciation phase-out begins January 2023, Mr. Peter would then be eligible for 80% bonus depreciation on the software and not the 100% that is obtainable in 2022.
Read also: Accumulated depreciation is what type of account?
Bonus depreciation examples and calculations
Let’s look at some more bonus depreciation examples and calculations:
Bonus depreciation example for business equipment
Take for instance you purchase factory equipment of $15,000 for your business in 2022 and put it to use. With the bonus depreciation rate at 100% for 2022, your bonus depreciation calculation would be:
100% x $15,000 = $15,000
This means that the bonus depreciation equivocates for the original purchasing price of the equipment which means you can deduct the entire price of the asset. This in turn reduces your income tax by $15,000.
Example of bonus depreciation on a vehicle
The vehicles that are operated as equipment (i.e tractors) or operated for hire (i.e taxis or transport vans) are considered business vehicles. They are eligible for bonus depreciation and have a maximum write-off of $10,200 for the first year plus an additional $8,000 in bonus depreciation for new and pre-owned (used) vehicles. As of 2022, the full 100% of the cost can be depreciated for SUVs with weights over 6,000 lbs, but are not heavier than 14,000 lbs.
In order to understand the use of bonus depreciation for vehicle depreciation, let’s take an example. Assume that a business owner purchases an eligible vehicle in 2018 for $60,000 and uses the vehicle only for business purposes. In 2018, there is a 100% bonus depreciation but this business owner is limited to an $18,000 depreciation deduction. That is, he can only deduct $18,000 from the cost of the vehicle. That is:
$60,000 – $18,000 = $42,000
As seen from the calculation above, this leaves a remaining adjusted basis of $42,000. This means that each year’s depreciation would be a percentage of the remaining $42,000 basis for 2019 through 2023.
Bonus depreciation example for rental property improvement
A taxpayer cannot claim bonus depreciation on an actual rental property but can claim this special depreciation allowance on properties that improve the interiors of commercial buildings or nonresidential real properties. This is known and categorized as a qualified improvement property.
For example, if a taxpayer buys a $2,000 washing machine for a rental property in 2023. The lifespan is 5 years, hence, using the straight-line depreciation method, he would have to depreciate the value of the machine by $400 every year until it is completely deducted. However, if he claims bonus depreciation on the washing machine, he can deduct a first-year bonus depreciation of 80% in the first year and then deduct the remaining $400 across the remaining years. That is:
80% x $2,000 = $1,600
This means that the taxpayer can deduct a bonus depreciation of $1,600 in the first year and deduct only $100 each year for the remaining 4 years.
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