What it means
Normally, when a company buys a machine or vehicle, the tax rules require it to deduct the cost gradually over the asset's recovery period. This matches the cost to the years the asset is used.
Bonus depreciation gives an extra, immediate deduction on top of or in place of that slow schedule. The reason governments offer it is to encourage investment.
A bigger deduction in year one cuts the tax bill straight away, which makes buying equipment cheaper after tax. Lawmakers have used it in different periods to push businesses to buy and build.
In the United States, the bonus percentage applies to qualifying property, which generally means business assets with shorter recovery periods and certain improvements. The rate is set by legislation and has been raised, lowered and phased down at different times.
Anyone using it must check the rate that applies to the year the asset is put into service. After taking the bonus deduction, the business depreciates the remaining cost in the normal way.
The total deduction over the life of the asset is the same as without the bonus, so it is a timing benefit, not extra tax relief overall. The gain comes from receiving the tax saving earlier.
Companies can often choose not to take bonus depreciation, which is useful if they have little taxable profit now but expect more later. A loss-making business may prefer to save the deductions for future years.
The decision should be made with a tax adviser. The tax deduction can differ from the figure in the financial statements.
Accounting depreciation usually follows the useful life of the asset, which creates a difference that is recorded as a deferred tax item.
In practice
Real-world examples
Example 1
A bakery buys a new $80,000 oven and takes bonus depreciation. The large first-year deduction reduces its tax bill, and the owner uses the saving to buy a delivery van. She makes a note that later years will have smaller deductions on the oven.
Example 2
A trucking company orders ten vehicles for $1,500,000 in total. Its accountant models whether to claim bonus depreciation or spread the deduction, and picks the former because profits are strong this year. The tax saved arrives within months, which helps pay the first loan instalments on the new fleet.
Example 3
A start-up with tax losses buys servers worth $60,000. Because it has no taxable profit now, the finance lead elects out of bonus depreciation to keep deductions for later years when profits are expected. The adviser documents the election so it is clear in later filings.
Think of it
Bonus depreciation lets you deduct most or all of an asset's cost immediately for tax purposes.
Formula
Calculation
First-year deduction = (Cost x Bonus rate) + (Remaining cost x Regular first-year depreciation rate)
Suppose a company buys equipment for $200,000 and applies an assumed bonus rate of 50%, used here only for illustration. The bonus deduction is 200,000 x 0.50 = $100,000. The remaining cost is 200,000 - 100,000 = $100,000.
For simplicity, assume the remainder is depreciated on a straight-line basis over five years, which gives 100,000 / 5 = $20,000 in year one. First-year deduction = 100,000 + 20,000 = $120,000.
At a 25% tax rate, the first-year tax saving is 120,000 x 0.25 = $30,000, compared with 40,000 x 0.25 = $10,000 under straight-line alone.Case study
Seen in the real world
Ironbridge Fabrication is a fictional metal-working firm that plans to buy $500,000 of new machinery. The finance manager compares claiming bonus depreciation with the regular schedule. Because the firm expects strong profits this year, a large deduction now has real value.
After modelling both routes, she recommends claiming the bonus. The extra tax saved in year one funds a second shift of operators. This illustrative story also notes a caution: the total deductions are unchanged, so later years show smaller deductions and slightly higher tax, which the budget must reflect.
She presents a simple table to the board showing the tax paid under each route over five years. The total is the same, but the bonus route moves the saving to the front. The directors approve the purchase and agree to review the plan again before any future equipment order.
Watch out
Common mistakes
- Thinking bonus depreciation creates extra deductions overall. It only brings deductions forward, and later years have smaller deductions.
- Assuming the rate is fixed. The percentage is set by law and can change, so the rate for the year of purchase must be checked.
- Claiming it automatically in every case. A business with low profits may be better off electing out and keeping deductions for later.
Questions
People also ask
Which assets qualify?
Generally business equipment and certain improvements with shorter recovery periods, but the detailed rules should be confirmed each year.
Does it change the accounts?
Not usually, because accounting depreciation follows useful life, and the difference is recorded as deferred tax.
Is it the same as Section 179?
No, because Section 179 is a separate expensing election with its own limits, although the two can be used together.
Watch