Bonus depreciation, also known as the additional first-year depreciation deduction or a 168(k) allowance, is a tax incentive that speeds up the depreciation process. It allows you to deduct a portion of the cost of eligible assets without depreciating it over its useful life.
Bonus Depreciation and the Phase-Out Timeline
Originally introduced to encourage business growth, bonus depreciation was further boosted by the 2017 Tax Cuts and Jobs Act, which permitted a 100% write-off of eligible costs of an asset in the first year.
Assets that qualify for this benefit include:
- Modified Accelerated Cost Recovery System (MACRS) property with a recovery period of 20 years or less, including office furniture and computer equipment.
- Depreciable computer software.
- Some improvements to the property.
- Certain film, television, and theater costs.
- Vacation property can be used as a short-term rental, such as an Airbnb (if it meets specific usage requirements).
- Residential rental estate (if you’ve conducted a cost-segregation study).
- Vehicles with a useful life of 20 years or less.
- Used equipment that you did not use before purchase.
The Benefit is Being Phased Out
While bonus depreciation has been instrumental to business growth, the provision is on its way out. Permissible deductions have been on the decline as of 2023 and will continue annually until it’s completely eliminated. The projected timeline for this is as follows:
- 2023: Bonus depreciation set at 80%.
- 2024: Drops to 60%.
- 2025: Reduced further to 40%.
- 2026: Limited to 20%.
- 2027 and beyond: Bonus depreciation is phased out completely.
5 Things to Take into Account In Your Financial Planning
As the benefit declines, you need to adjust your finance strategy accordingly. This includes managing your asset purchases, tapering your spending, and preparing for changing tax impacts. Consider these steps as part of your approach:
1. Accelerate Purchases to Maximize Deductions
To take advantage of the highest bonus depreciation rates, accelerate your purchase plans for eligible assets. For example, the assets you purchased in 2024 will still benefit from a 60% deduction, compared to only 40% in 2025. Strategic timing can make a significant difference in your cash flow and tax savings.
2. Explore Alternative Depreciation Methods
Consider other tax-saving options like Section 179 expensing, which also allows you to immediately deduct certain asset costs. However, it comes with investment limits and is tied to taxable income, making it particularly useful for smaller businesses.
3. Prioritize Essential Purchases
Focus on acquiring assets that are critical to your operations rather than discretionary purchases. This ensures that limited tax benefits are used wisely and in support of long-term growth.
4. Budget for Increased Tax Liabilities
As bonus depreciation rates decline, incorporating higher taxable income and increased tax liabilities into your cash flow forecasts will help ensure you maintain smooth operations.
5. Consider Leasing vs. Purchasing
With declining bonus depreciation benefits, leasing might become a more viable option for acquiring assets. Leasing reduces upfront costs and provides flexibility. Consult with your financial advisor to understand the benefits for you.
Partner With a Tax Expert
To maximize your tax deductions and ensure regulatory compliance, you need to understand the tax laws and keep accurate records to justify your claims. Misinterpretations can lead to costly penalties. That’s where working with a tax professional comes in handy. Not only do they stay abreast of the changing laws, but they also guide you in terms of adjusting your financial strategy. This is what our CPAs do at Fusion. Whether you run a small business or a large enterprise, we delve into all tax credits and ensure your financial planning aligns with your cash flow needs. Contact us for assistance today!
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