- Entrepreneurs should maximize deductions and depreciation as part of their tax strategy.
- While most owners regularly depreciate assets during tax time, many do not consider the benefits of bonus depreciation.
- Depreciation allows a company to write down an asset at its fair market value or cost over the expected time it will be used. Bonus depreciation allows owners to speed up this process.
- This article is for business owners who want to take advantage of bonus deductions when filing their tax returns.
Every business owner wants to find ways to maximize their deductions and write-offs for key business assets each year. While you probably already benefit from regular asset depreciation, you may not benefit from bonus depreciation.
Not sure what bonus amortization is or how it works? This guide explains how to apply bonus depreciation to your expensive assets during tax season this year.
What is bonus debit?
Depreciation is a tax strategy that allows a company to depreciate the fair market value or cost of an asset over an expected useful life (how long the company estimates the asset will be used for business needs).
For example, a moving company uses a large truck for its primary business activities. The truck costs $100,000, and when the company buys it, the owner estimates that the company will use the truck for 10 years. That means they can write off $10,000 in expenses each year on their tax return up to the 10-year limit.
That's a significant write-off, but not necessarily enough for most business owners. That's where bonus amortization comes in.
Bonus depreciation allows business owners to speed up the depreciation process. Companies can then write off the cost of an asset for more than one year in the same year they start using it. In the example above, that business owner could write off more than $10,000 when they bought the truck for that tax year.
The amount of bonus amortization you can write off depends on the tax year. Under the Tax Cuts and Jobs Act of 2017 (TCJA), companies can write off up to 100% of costs for eligible assets or property purchased after September 27, 2017 and before January 1, 2023. owners can only write off up to 50% of a given asset.
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That sounds nice now, but the 100% depreciation limit will start to decrease after 2022. According to Nolo, the depreciation bonus rate will decrease in the coming years as follows:
- 2023: Max depreciation up to 80%
- 2024: Max depreciation up to 60%
- 2025: Max depreciation up to 40%
- 2026: Max depreciation up to 20%
To summarize, companies can normally only write off the cost of a particular asset for one year to get a better tax return. Bonus depreciation allows companies to write off more than one year's cost of the asset instead. [Read related article: Which Business Assets Are Tangible?]
FOR YOUR INFORMATION: Bonus depreciation can now be applied to real estate. Before the TCJA, only new real estate was eligible for bonus amortization on tax returns. Be sure to carefully read the IRS's rules on how to use real estate amortization bonuses.
How does bonus debit work?
To take advantage of bonus write-offs, start by determining if you have qualified business property. Once you have discovered that you have a qualifying property, you must start using the asset in the correct tax year.
For example, the moving company described above bought a new moving van in December 2021. However, they do not plan to commission it in January 2022. In that case, the company would have to wait until the 2022 tax return to file a claim. any bonus depreciation on the moving truck.
Then, the company must claim the bonus amortization on the company's tax returns. In the example above, the moving company could claim up to 100% depreciation for the cost of the moving truck using Form 4562. This form is filed along with the primary business tax return paperwork.
Choose from bonus debit
While bonus amortization can be helpful, some companies may want to opt out. Here are a few reasons why you might want to opt out of bonus amortization:
- You want your tax return to be more stable or consistent.
- You missed the window to write off 100% of the cost.
- Your accountant advises you not to take a bonus write-off.
You are never forced to take bonus asset write-offs, and you can opt out by attaching a statement to your business tax returns.
However, any bonus amortization opt-out must be done individually by each owner. In such circumstances, you can use MACRS depreciation methods or other strategies instead.
How do you qualify for bonus amortization?
While bonus amortization is technically available to any business owner, only certain types of real estate qualify. Let's take a look at how to qualify for bonus amortization.
To be eligible for bonus amortization, your company must have company assets that meet at least one of the following criteria:
- It has a maximum lifespan of 20 years or less. For example, land and buildings are excluded because these assets can be used for much longer than 20 years.
- It is a qualified improvement property, which includes properties that enhance the interior of non-residential real estate or commercial buildings.
- It is used for qualified film, television or live theater productions.
- It can be used for both business and personal use (e.g. cameras and vehicles).
There are also multiple restrictions on the use of bonus debits on vehicles. The IRS has several bonus depreciation limits for vehicles, so business owners can't claim large tax deductions on cars that are primarily for personal use.
The bottom line is that bonus amortization can only be used on real estate that your company owns, is used for income-generating activities, and has a determinable useful life. The IRS maintains a detailed list of all eligible property types for regular and bonus depreciation.
There are also some limitations to keep in mind when claiming bonus amortization. In addition to the above restrictions on publicly traded real estate, you cannot use the full bonus depreciation amount if you also use the Section 179 expense deduction, which allows your company to write off the cost of a particular qualifying real estate right away. It serves a similar purpose to bonus amortization, but it's not exactly the same.
For example, you can't claim Section 179 unless you have a taxable profit to report. Suppose your business has only $10,000 in taxable income before taking the Section 179 deduction. From there, you decide to buy $20,000 worth of machinery or equipment. Your Section 179 deduction is limited to just $10,000. Then you can either claim regular depreciation on the remaining $10,000 or carry over the unused deduction to the next tax year.
Include bonus depreciation in your tax return
Recording or claiming the bonus depreciation for an asset on your tax return is quite simple. Simply use IRS Form 4562, which allows you to record and review any bonus charges from your company.
This same form is used to claim other types of write-offs, such as the Section 179 deduction. Read the full instructions for Form 4562 to make sure you're not missing out and that you're calculating your bonus amortization accurately.
FOR YOUR INFORMATION: The right accounting software can help you track bonus amortization so you're ready for tax season. Check out our reviews of the best accounting software and our list of the best small business tax software for small businesses.
Entrepreneurs can use bonus amortization to reduce their taxable income on their tax return. Bonus depreciation can help you maximize the value of a newly purchased asset sooner rather than later.
However, make sure to use the bonus amortization carefully and when it makes economic sense. You may want to consider hiring an accountant before using bonus write-offs, especially for multiple assets.