Bonus Depreciation

Bonus depreciation is an additional first-year depreciation deduction that lets a taxpayer write off a percentage of the cost of qualifying business property immediately rather than over the years the tax code otherwise assigns to it. The percentage is now 100 percent, so for most equipment purchases the entire cost is deductible in the first year.

The popular name appears nowhere in the statute. Internal Revenue Code section 168(k), which creates it, is headed "Special allowance for certain property," and the IRS calls it the additional first-year depreciation deduction. All three names describe the same provision. It is worth keeping distinct from section 179 expensing, which reaches a similar result by a different route and under different limits, and from depreciation generally, which is the multi-year deduction bonus depreciation accelerates.

The 100 percent rate is current law, and most written material about bonus depreciation describes a schedule that no longer applies. The 2017 tax act set the rate at 100 percent and then stepped it down: 80 percent for 2023, 60 percent for 2024, 40 percent for 2025, heading to zero. The 2025 budget reconciliation act, Public Law 119-21, repealed that phase-down and restored 100 percent permanently. The effective-date rule in section 70301(c)(1) of that act is what matters in practice: the amendments "shall apply to property acquired after January 19, 2025." Property acquired on or before that date stays on the old schedule, which for 2025 meant 40 percent.

Acquisition, not purchase or delivery, is the pivot, and it has its own rule. Section 70301(c)(4) provides that "property shall not be treated as acquired after the date on which a written binding contract is entered into for such acquisition." So a machine ordered under a binding contract in December 2024 and delivered in 2026 was acquired in 2024 for this purpose, however late the invoice is dated. There is also a one-time transitional election at section 168(k)(10): for the first taxable year ending after January 19, 2025, a taxpayer could elect 40 percent instead of 100 percent, or 60 percent for certain long-production-period property and aircraft.

What qualifies is broader than "equipment." Section 168(k)(2)(A)(i) reaches depreciable property with a recovery period of 20 years or less, which covers most machinery, vehicles, computers, furniture and land improvements, plus certain computer software, water utility property and specified film, television, theatrical and sound recording productions. What it does not reach is the building itself, since nonresidential real property and residential rental property have recovery periods far longer than 20 years. Section 168(k)(9) also excludes property used in certain regulated utility businesses and in businesses with floor plan financing indebtedness.

Used property counts, which was not always true. Section 168(k)(2)(E)(i) requires only that the property "was not used by the taxpayer at any time prior to such acquisition" and that the purchase satisfy the related-party and anti-churning conditions borrowed from section 179(d). A second-hand delivery van bought from an unrelated seller therefore qualifies in full.

The absence of an income limit is the sharpest contrast with section 179. Section 179(b)(3) caps that deduction at the taxpayer's active trade or business taxable income. Section 168(k) contains no equivalent limitation, so bonus depreciation can push a business into a loss. Whether that loss can actually be used in the current year is a separate question governed by other rules, including the at-risk, passive activity and excess business loss limitations, and state income tax conformity is separate again: a state's income tax does not automatically follow section 168(k).

A business buys qualifying property and places it in service during the tax year. Unless it elects out, section 168(k) automatically adds a first-year allowance equal to 100 percent of the property's adjusted basis, and section 168(k)(1)(B) reduces the basis by that amount before any ordinary depreciation is computed. Where a section 179 election is also made, the section 179 amount comes off first, because it is treated as an expense not chargeable to capital account, and bonus depreciation applies to whatever adjusted basis remains. Electing out is done under section 168(k)(7) for an entire class of property, not asset by asset, and the election can be revoked only with the consent of the IRS.

A hypothetical example. A landscaping company buys an $85,000 wood chipper and places it in service in the year. With bonus depreciation the whole $85,000 is deductible immediately and the chipper's basis drops to zero. At a 24 percent marginal rate, that deduction is worth $20,400 of tax this year. The company has not received $85,000 of extra deductions, though: it has moved them forward. There is no depreciation left to claim on the chipper in any later year, and if the company sells it three years on for $40,000, the whole $40,000 is gain because the basis is zero. Depreciation recapture then determines how that gain is taxed.

Pros

• The full cost of qualifying property is deductible immediately, which improves cash flow in the year of purchase.
• There is no dollar ceiling, so it scales to large capital programs in a way section 179 expensing does not.
• There is no taxable-income limitation, so it can be used by a business with a loss year or a business whose income is too small to absorb a section 179 election.
• Used property qualifies, so a buyer of second-hand equipment gets the same treatment as a buyer of new.
• It applies automatically, so nothing is lost by forgetting to elect it.

Cons

• It is a timing benefit only. The property's basis is reduced to the extent of the deduction, so the deduction is unavailable later and the eventual sale produces more gain.
• Taking a large deduction in a low-income year can waste it, spending deductions against a low marginal rate that would have been worth more spread across higher-rate years.
• The loss it creates may be trapped by the at-risk, passive activity or excess business loss rules rather than usable now.
• Not every state conforms to section 168(k), so a deduction taken federally may have to be added back on the state return and recovered over time.
• Because it is automatic, a business that would rather spread the deduction must remember to elect out for the whole class of property.