Bonus Depreciation can be a very powerful tool for businesses, and the large amount of initial depreciation can provide a significant reduction in tax liability quickly.

The Tax Cuts and Jobs Act (TCJA) increased Bonus Depreciation to 100% for eligible property.

However, not all businesses can benefit from Bonus Depreciation, and there are some scenarios in which spreading the depreciation over several years may be more advantageous.

In such cases, the business may opt out of Bonus Depreciation and follow the regular method of depreciation instead.

We will discuss the election process, including the IRS rules and forms, and explain what implications the election has for a business once it has been made for a particular tax year.

In our guide to the Bonus Depreciation election process, we will also outline the advantages of Bonus Depreciation and provide the reader with information regarding the latest updates released by the IRS regarding Bonus Depreciation.

What Is Bonus Depreciation? Key Concepts and History

Bonus depreciation allows for a large upfront tax deduction for the purchase of eligible property placed in service. The goal of bonus depreciation is to encourage investment in new capital by allowing for immediate expensing of a large portion of the cost of such property.

Historically, the amount of bonus depreciation allowed has fluctuated and was initially intended as a temporary amendment to the Internal Revenue Code. However, bonus depreciation has become a staple in tax planning and was dramatically increased by the TCJA in 2017 to 100% of the cost of eligible property for several years.

A brief overview of key terms for bonus depreciation follows:

• Eligible Property: Most property, including machinery, equipment, computers, appliances, and certain improvements to property.
• Used Property: As of 2018, used property that meets certain requirements is considered to be eligible for bonus depreciation.
• Immediate Deduction: The large upfront tax deduction that is allowed for the purchase of eligible property.

This powerful tax tool is especially useful for very capital-intensive companies. Not only does it increase cash flow in the year of purchase, but it also allows the company to reinvest the money saved in additional growth initiatives sooner.

However, as with any tax planning tool, there are some companies that would be better off taking their depreciation over a longer period of time. How the bonus depreciation deduction affects different industries is an important factor to consider.

The TCJA and the “Big Beautiful Bill”

In December 2017, President Trump signed into law the Tax Cuts and Jobs Act (TCJA), commonly referred to as the “Big Beautiful Bill.” The TCJA includes many significant changes to the Internal Revenue Code, including several amendments to bonus depreciation.

Perhaps the most significant amendment is an increase in bonus depreciation from 50% to 100% for qualified property acquired by a taxpayer other than by purchase (e.g., construct, etc.) after September 27, 2017. The increased bonus depreciation is intended to immediately provide a large tax deduction for a significant expenditure by a business to increase cash flow.

Key impacts of the TCJA include:

• Enhanced Cash Flow: The increased bonus depreciation is intended to immediately provide a large tax deduction for a significant expenditure by a business to increase cash flow.
• Inclusion of Used Property: The amended bonus depreciation rules include used property (e.g., used machinery, used computers, etc.), thereby qualifying a broad range of property for bonus depreciation. Used property previously did not qualify for bonus depreciation.
• Stimulated Investment: The TCJA also includes several other provisions which are intended to stimulate business investments in new assets (e.g., technology, equipment, etc.) as well as other expenditures by a business to increase cash flow.

Importantly, while the amended bonus depreciation rules are intended to increase cash flow and stimulate business investments, a business must carefully consider its overall tax strategy when deciding whether to claim bonus depreciation on certain property. In some cases, a business may be better off not electing to claim bonus depreciation on certain property as part of a broader financial planning strategy. Importantly, a business should consult with its tax advisor to determine how the TCJA provisions, including the amended bonus depreciation rules, will affect not only a business’s current tax obligations, but also its future tax obligations.

Bonus Depreciation in Real Estate and Other Industries

In Addition to Bonus Depreciation: How to Use It to Increase Cash Flow in Real Estate and Other Industries

Bonus depreciation in real estate, and other industries, can provide significant increases to the after-tax cash flow of an investor by allowing the immediate expensing of the improvements to a property.

In real estate, improvements to a property, such as renovations or qualified improvement property, can be claimed under bonus depreciation.

In addition to real estate, bonus depreciation can also be of significant value to industries such as manufacturing and retail, where high upfront costs to acquire new assets can provide a substantial amount of tax savings when those assets qualify for bonus depreciation.

The industries that use bonus depreciation most are:

• Real Estate: Improvements, renovations, and qualified improvement property.
• Manufacturing: New machinery and technology.
• Retail: New store fixtures as well as new improvements to the client-facing areas of a retail store.

While there is also potential negative impact to using bonus depreciation in real estate and other industries, such as reduced deductions in following years, it is generally beneficial to most businesses. In order to receive the benefits of bonus depreciation, however, one must understand the criteria that qualify for it and acquire the assets within the time frame that is allowed by the schedule of depreciation. Also, it is generally better for companies that want to take the same amount of deductions for each year, rather than taking large amounts in certain years, to elect out of bonus depreciation. Consult with a financial advisor to determine the best way to utilize bonus depreciation in order to increase cash flow in real estate and other industries to reach the goals of the business’s growth.

Bonus Depreciation Phase Down: 2025 and Beyond

The bonus depreciation phase-down period for businesses is coming. In 2023, the rate for the deduction will start decreasing from 100% to lower percentages. It will be important to have a good grasp of the scheduled percentages to do proper tax planning.

In 2025, the deduction percentage will decrease significantly. The percentage will phase down on a yearly basis to 20% and will continue to decrease until 2027.

Here is the breakdown of the phase-down percentages:

• 2023: 80%
• 2024: 60%
• 2025: 40%
• 2026: 20%
• 2027: 0%

This decrease in deduction percentage for bonus depreciation will require businesses to adjust their tax strategy for purchasing assets. The decreases in the percentage of the deduction for bonus depreciation will require companies to relook at their financial projections based on decreased deductions for newly acquired assets. Businesses will need to make a decision on whether to purchase assets in 2022 or 2023 to take advantage of the higher percentage of the deduction for bonus depreciation. The earlier a business acquires an asset within a scheduled time frame of decreasing percentages, the better the tax savings for that year. It is very important to have a solid tax plan and seek the advice of a tax professional to get the most tax savings from the acquisition of new assets.

Why Would You Elect Out of Bonus Depreciation?

The decision to opt out of bonus depreciation has several factors that need to be considered to determine the best course of action for your specific tax situation.

While choosing to opt out of bonus depreciation allows for the spreading of deductions over several years of a business’s life, which can help to stabilize a business’s tax liability, especially if the business expects to have higher income in future years.

On the other hand, choosing to opt out of bonus depreciation could result in a business missing out on the potential for immediate tax relief that could otherwise immediately enhance a business’s current cash flow and investments.

Below are some of the pros and cons of choosing to opt out of bonus depreciation.

• Pros:

  • Spreads out deductions over time of business
  • Stabilizes tax liability over time of business
  • Can help to align future profit expectations

• Cons:

  • Delays potential for immediate tax savings for business
  • Misses out on immediate enhancement of current cash flow and investments

Choosing to opt out of bonus depreciation should be a well thought out decision that considers both the short-term and long-term financial goals of a business. It would be wise to seek the advice of a tax professional to help decide whether or not choosing to opt out of bonus depreciation would help to meet your specific strategic financial objectives.

How to Elect Out of Bonus Depreciation: Step-by-Step Process

Deciding whether to forgo bonus depreciation involves a number of specific steps and strict guidelines.

If you choose to forgo bonus depreciation for a given year for certain classes of property, your election is made on your timely filed (including any extensions) return for that year.

Note that your decision to forgo bonus depreciation is an irrevocable decision with respect to the tax year in which you made the decision and for each class of property for which you made the decision.

Determine whether forgoing bonus depreciation is best for you and your business based on your specific financial circumstances, and discuss your options with your tax advisor to ensure you are meeting all applicable requirements to claim forgoing bonus depreciation and to determine the tax implications to you.

Key Steps for Making an Election to Forgo Bonus Depreciation:

1. Identify the Properties: List all of the properties for which you are determining whether to claim forgoing bonus depreciation for the tax year under consideration.
2. Consult With Your Tax Advisor: Determine the implications to you of forgoing bonus depreciation for the properties for which you are considering forgoing bonus depreciation.

Complete the necessary IRS tax forms, including Form 4562, Depreciation and Amortization: For each of the classes of property for which you are determining whether to forgo bonus depreciation, complete all necessary information on the required form (e.g., Form 4562) to report depreciation for each piece of property, including to make an election to forgo bonus depreciation for the class of property for which such election is to apply.

Documentation and Filing for Electing Out:

• File the Appropriate Form for Your Specific Situation (e.g., Form 4562): Attach the completed form to your return.
• Keep a Copy of Supporting Documentation: It is always a good practice to keep a copy of any supporting documentation for an election for which you are claiming a tax benefit. This will protect you in the event that the IRS audits your return for which the election was made.

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Accurately and completely file all necessary tax returns, as incomplete or inaccurate returns could result in the denial of an election (and all related corresponding tax benefits for the relevant class or classes of property for the tax year for which the election was to apply), in addition to potential penalties.

Follow the IRS when updated tax information becomes available for future tax years to remain compliant with changing tax laws for future tax filing.

IRS Guidance, Forms, and Recent News

The IRS offers several tools to assist businesses with bonus depreciation elections. By knowing the current rules and regulations, businesses can avoid errors that can cost thousands of dollars.

The IRS frequently updates forms and publications to reflect current depreciation rules and to include new information. Businesses must use the most current version of the forms to avoid errors when filing their tax returns. Businesses can receive the latest information regarding bonus depreciation by regularly visiting the IRS website for the latest announcements.

Helpful IRS Resources for Bonus Depreciation:

• IRS Form 4562: Depreciation and Amortization.
• IRS Publications: Information on the detailed rules for depreciation of assets.
• IRS Website: Latest information on bonus depreciation, including the latest news.

The recent IRS news on the bonus depreciation phase down highlights the importance of planning for the phase down in bonus depreciation over the next few years. By staying current on the latest information on bonus depreciation from the IRS, businesses can plan for future years to receive the maximum depreciation.

Strategic Tax Planning: When to Elect Out

Knowing when to elect out of bonus depreciation is very important for effective tax planning. There is no one-size-fits-all answer to this issue. Each company must weigh its current situation with its future situation.

A company that anticipates higher earnings in future years may want to spread out the depreciation of its assets. It could elect out of bonus depreciation and spread the depreciation of its assets over the alternative minimum tax (AMT) useful life, as opposed to the regular useful life. However, if a company needs immediate tax relief, it may be better off sticking with the bonus depreciation.

Considerations for Electing Out of Bonus Depreciation:

• Future Earnings: Anticipated earnings in future years.
• Cash Flow Needs: Short-term vs. long-term cash flow needs.
• Tax Rate Changes: Expected changes in tax rates.

It is recommended that a company make these types of depreciation decisions with the aid of a tax advisor. The company’s financial situation and strategic growth plans should be the deciding factors in the company’s decision-making process.

Common Mistakes and Compliance Tips

Bonus depreciation has its pitfalls, and one of the biggest pitfalls is not making the election on time and all the consequences that follow. Making the election and realizing your strategy is off is a huge problem for businesses.

It’s a problem that can be mitigated with knowledge of the rules and best practices, very good documentation, and a very good review of what you’ve done.

Tips for Compliance:

• File on Time: Make your election with your original return.
• Document Completely: Make sure you have documented all your decisions regarding assets.
• Stay Current: Keep up to date with the latest IRS announcements and changes.

Conclusion: Making the Right Choice for Your Business

Choosing not to elect bonus depreciation is a big decision. It should be tied to your business’s current and future financial goals and tax objectives. Make sure you understand the full impact that your decision will have on your cash flow and future tax liability.

It may be helpful to speak with a tax professional to gain more insight into the matter. Analyze your options and make the best decision for your current and future financial well-being.

As tax laws change, be proactive and review your options often to continue to meet your business objectives.