Editorial · January 26, 2018
Bonus Depreciation: How the 100 Percent Rule Works
Bonus depreciation lets a business deduct the full cost of many new and used assets in the first year, instead of spreading the cost over many years. Under the tax law signed in December 2017, the rate is now 100 percent for property bought and placed in service after September 27, 2017. This guide explains what that means in plain terms.
What bonus depreciation is
Normally, when a company buys a machine, a truck or a computer, it cannot deduct the whole price at once. The tax code makes it write the cost off a little each year. The schedule depends on the type of asset. This is called depreciation.
Bonus depreciation is an extra deduction on top of that schedule. Before the new law, the bonus was 50 percent of the cost for property placed in service in 2017. The new law raises it to 100 percent. That means a business can write off the whole cost in the year the asset goes into use.
A faster write-off lowers taxable income sooner. It does not change what the asset costs. It changes when the tax benefit shows up.
The 100 percent rule and its dates
Public Law 115-97, often called the Tax Cuts and Jobs Act, sets a schedule by the year the property is placed in service. Placed in service means the asset is ready and available for use in the business.
- From September 28, 2017, for about five years: 100 percent.
- The next year: 80 percent.
- The year after that: 60 percent.
- Then 40 percent, then 20 percent.
The rule is temporary. After the 20 percent year, the bonus ends unless Congress acts again.
The date of purchase matters too. The 100 percent rate applies only to property acquired after September 27, 2017. If a business signed a binding written contract to buy the asset on or before that date, the asset does not count as acquired after it.
Assets bought before September 28, 2017, but placed in service later get a lower, phased rate. The law gives them 50 percent if placed in service in 2017, 40 percent in 2018 and 30 percent the year after that.
There is also a choice for the first tax year that ends after September 27, 2017. A business may elect to take 50 percent instead of 100 percent for property placed in service that year. The election must be made in the form and manner the Treasury sets.
What property qualifies
The main test is the type of asset. Qualified property includes tangible property with a recovery period of 20 years or less. That covers most equipment, machinery, furniture and vehicles used in a business. It also covers certain computer software that the public can buy off the shelf, and water utility property.
Buildings do not fit this test. A building has a recovery period of 27.5 or 39 years, which is longer than 20.
The big change in the new law is used property. Before, bonus depreciation was mostly limited to new assets. Now used property can qualify too. There are two conditions. The taxpayer must not have used the property before buying it. And the purchase must meet the usual Section 179 acquisition rules, which means it cannot be bought from a related party and similar limits.
The law also carves out some businesses. It excludes property used mainly in a trade or business that has floor plan financing, such as some vehicle and equipment dealers, when that interest is taken into account in the new business interest limit. It also excludes property used mainly in certain regulated utility businesses.
How it differs from Section 179
Section 179 is the other way to deduct equipment costs fast. People often mix the two up. They work differently.
Section 179 has dollar caps. The new law raises the limit from $500,000 to $1,000,000. It also raises the point where the deduction starts to shrink, from $2,000,000 to $2,500,000 of total equipment purchases. These changes apply to tax years that begin after December 31, 2017.
Bonus depreciation has no dollar cap. A business of any size can use it, however much it spends.
Section 179 also has a business income limit. The deduction cannot be larger than the income from the business. Bonus depreciation has no such limit, so it can create or increase a loss for the year. Section 179 is picked asset by asset, while bonus depreciation applies to an entire class of property unless the business elects out for that class.
Many businesses use both. They take Section 179 first on the assets they choose, then let bonus depreciation cover the rest.
Vehicles and other limits
Passenger cars face a separate cap. Section 280F limits the yearly depreciation on cars used for business. The new law raises the first-year cap from $2,560 to $10,000. The second-year cap rises from $4,100 to $16,000, the third from $2,450 to $9,600, and each later year from $1,475 to $5,760. The new limits apply to cars placed in service after December 31, 2017, and are indexed for inflation.
Heavier vehicles, such as some trucks and vans, may fall outside the car cap. The rules depend on the weight rating and on how the vehicle is used, so a tax adviser should check the details.
The law also removes computers and peripheral equipment from the list of listed property. This makes the record keeping for them lighter than before.
Questions to ask before you buy
A few plain checks help before a large purchase.
- When will the asset be placed in service? The date sets the rate.
- When was the purchase contract signed? A contract on or before September 27, 2017, changes the rate.
- Is the property new, or used and never used by you before?
- Will the deduction create a loss? A loss may carry to other years, and the business should plan for that.
- Does a faster write-off help now? Taking a large deduction today leaves smaller deductions later.
Your tax adviser can run these numbers for your return. The law is new, so details may change as the IRS explains it. Check the IRS site and Publication 946 for updates.