How to calculate bonus depreciation

For taxpayers, knowing how to calculate bonus depreciation is essential. Depreciation in accounting is a way of allocating the cost of a tangible (fixed) asset throughout its useful life. It is the estimated value of an asset that has been spent. Over the years, Congress has repeatedly provided extra incentives such as bonus depreciation to businesses in order to encourage them to acquire capital assets for their firms.

Hence, taxpayers that are looking for ways to minimize short-term tax liabilities usually elect to claim bonus depreciation. This special depreciation deduction accelerates depreciation by allowing taxpayers to write off a large percentage of the cost of an eligible asset in the first year that the asset was purchased. While the remaining cost of the asset can be deducted using regular depreciation over multiple years until it phases out. In this article, we will discuss how to calculate bonus depreciation but first, let’s have an understanding of bonus depreciation.

How to calculate bonus depreciation
How to calculate bonus depreciation

Related: Can you take bonus depreciation on rental property?

What is bonus depreciation?

Bonus depreciation is an accelerated tax deduction that allows a taxpayer to deduct a large percentage of the purchase price of an eligible asset in the first year that it was purchased instead of writing them off over the useful life of the asset. Bonus depreciation is also known as the additional first-year depreciation deduction, special allowance, or IRC §168 (k) depreciation. This type of tax incentive accelerates tax savings and makes an asset that you placed in service more affordable.

When a business taxpayer purchases an asset, the tax treatment for that asset is usually to spread the cost of the asset over its useful life; known as depreciation expense which in turn reduces the net income of the business. However, bonus depreciation as an accelerated business tax deduction lowers a company’s taxable net income, hence, reducing its tax liability. That is, Congress enacted rules that allow taxpayers to deduct a fixed percentage of an eligible asset’s cost upfront rather than allocating the cost over the life of the asset.

This business tax incentive was first enacted by Congress’ Job Creation and Worker Assistance Act of 2002. However, in 2017, the passage of the Tax Cuts and Jobs Act (TCJA) made significant changes to the rules. It enacted 100% bonus depreciation that allows businesses and taxpayers to immediately write off 100% of the cost of eligible assets acquired and placed in service after Sept. 27, 2017, and before Jan. 1, 2023. Before the TCJA, it was just a 50% write-off of eligible property.

Nonetheless, the 100% write-off of eligible property expired on Dec. 31, 2022, and unless the law changes, the bonus percentage for property placed in service after Dec. 31, 2022, and before Jan. 1, 2027, will decrease by 20 points each year. Also, only new and used property with a less than 20-year Modified Accelerated Cost Recovery System (MACRS) life will qualify for bonus depreciation.

Hence, in order to claim bonus depreciation, you have to, first of all, purchase a qualified business property and then put it into service prior to year-end. Then, report bonus depreciation to the Internal revenue Service (IRS). So assuming an asset qualifies for bonus depreciation, let’s further discuss how to do the bonus depreciation calculation for such an asset.

See also: Adjusting Entry for Depreciation

How to calculate bonus depreciation

You must calculate the amount of bonus depreciation in order to recognize and report your special depreciation allowance under Part II, Line 14 on form 4562. In order to figure out the depreciable base of the asset, you have to subtract any deductions or credits allocated to the property (if any) from the basis of the asset. That is, you subtract section 179 expense from the original cost of the asset or reduce the basis of the asset by the applicable percentage of any credits you might have claimed (e.g energy credit).

Then, to calculate bonus depreciation, you have to multiply the bonus depreciation rate by the remaining cost of the asset. That is, the formula for bonus depreciation calculation is:

Bonus depreciation rate (e.g 100% for 2022) X Cost of the eligible asset

After the bonus depreciation calculation, the product yielded is the amount of bonus depreciation you can claim for the tax year. Hence, you then deduct the amount gotten from the cost of the asset. For instance, if you purchase a piece of equipment for $10,000 in 2022 and put it in service, you will get the whole $10,000 bonus depreciation (i.e 100% of $10,000). That is, you can write off the whole $10,000 in that tax year 2022.

However, if you bought the same $10,000 piece of equipment in 2023, the bonus depreciation calculation would be different. You will get an $8,000 bonus depreciation instead (i.e 80% of $10,000); this means you deduct $8000 from $10,000 in the tax year 2023 while the remaining $2,000 will be written off using regular depreciation over multiple years until it phases out

Taxpayers can claim 100% bonus depreciation on property that has been placed in service before 2023. However, for any eligible property placed in service after 2022, the following bonus depreciation rate applies:

The year the asset was placed In serviceBonus depreciation rate
2025 40%
2026 20%
2027 0%
Bonus depreciation phase-out schedule

These are the rates used for the bonus depreciation calculation in accordance with the year in which the property was put in service. For instance, if you purchased a new computer software in December 2022, but didn’t put the software into service until January 2023, you would have to wait until you’ve filed your 2023 tax return to claim bonus depreciation on the software. Since the bonus depreciation phase-out begins in January 2023, you would only be eligible for 80% bonus depreciation on the software and not 100%.

Check out: Accumulated depreciation is what type of account?

Examples of bonus depreciation calculation

Here are some examples of how to calculate bonus depreciation:

How to calculate bonus depreciation: example 1

Assume ABC company purchased $500,000 worth of equipment on Jan 2, 2022, and placed them in service. This property is qualified for bonus depreciation because it has a recovery period of 20 years or less. Hence, in order to calculate bonus depreciation, we multiply the 100% bonus depreciation rate for 2022 by the cost of the equipment. That is:

$500,000 X 100% = $500,000

This means that, for 2022, ABC company is allowed a depreciation deduction of the entire $500,000.

On the other hand, let’s assume ABC company purchases and places the $500,000 worth of equipment in service on January 10, 2023. The bonus depreciation that can be claimed for this will be different compared to the first bonus depreciation calculation because of the 80% bonus depreciation rate for the year 2023. Hence, in order to calculate bonus depreciation, we multiply the 80% bonus depreciation rate for 2023 by the cost of the asset. That is:

$500,000 X 80% = $400,000

This means a $400,000 bonus depreciation can be claimed which is deducted from the cost of the asset:

$500,000 – $400,000 = $100,000 depreciated value of the asset

This means that the remaining $100,000 is depreciated under the general depreciation system, beginning in 2023 using the 200-percent declining balance method. This is a typical example of how to calculate bonus depreciation for 2023.

Bonus depreciation calculation: Example 2

Assume, in January 2022, you purchased office furniture and paid $500 for the furniture. Office furniture is seven-year MACRS property, and you are claiming 100% bonus depreciation. You do not have any other applicable credits or deductions, so the bonus depreciation calculation would be:

100% x $500 = $500

This means you can claim a total of a $500 depreciation deduction when you file your 2022 tax return.

On the other hand, assume you purchased the office furniture in 2022 but placed it in service in 2023. Bonus depreciation declines by 20% after December 31, 2022. Hence, the bonus depreciation calculation would be:

80% x $500= $400

This means your 2023 bonus depreciation will be $400. While the remaining $100 of the cost of the asset will be depreciated under the normal MACRS rules for 7 years.

See also: Where is accumulated depreciation on the balance sheet?

Last Updated on November 2, 2023 by Nansel Nanzip Bongdap

Obotu has 2+years of professional experience in the business and finance sector. Her expertise lies in marketing, economics, finance, biology, and literature. She enjoys writing in these fields to educate and share her wealth of knowledge and experience.