Bonus Depreciation Sunset: What Businesses Should Know
Understand how the gradual phase-out of bonus depreciation impacts your ability to deduct asset costs and what it means for your business's tax strategy.
Bonus depreciation is a tax incentive that permits businesses to immediately deduct a significant percentage of the cost of certain assets, rather than writing them off over many years. This mechanism was expanded by the Tax Cuts and Jobs Act of 2017 (TCJA), which introduced a 100% bonus depreciation rate that allowed for a full, immediate write-off for eligible property. The period of 100% bonus depreciation has now concluded, and the benefit is in a “sunset” period. This means it is being systematically reduced over several years, which has considerable implications for business investment planning.
The Bonus Depreciation Phase-Out Schedule
The TCJA initially allowed businesses to deduct 100% of the cost of qualified property placed in service after September 27, 2017, and before January 1, 2023. This incentive is now subject to a structured phase-out, where the percentage of an asset’s cost that can be immediately expensed decreases by 20 points each year. The bonus depreciation rate is determined by the year the property is placed in service:
- 2023: 80%
- 2024: 60%
- 2025: 40%
- 2026: 20%
Barring any legislative changes, the bonus depreciation rate will be 0% for property placed in service in 2027 and all subsequent years. A slightly different phase-out schedule applies to certain property with long production periods and some non-commercial aircraft, but this primary schedule impacts most business acquisitions.
Defining Qualified Property
For an asset to be eligible for bonus depreciation, it must be considered “qualified property.” The primary requirement is that the property must be subject to depreciation under the Modified Accelerated Cost Recovery System (MACRS) and have a recovery period of 20 years or less. This includes most tangible business assets like machinery, equipment, vehicles, furniture, and fixtures. Computer software is also a category of qualified property, referring to off-the-shelf software that is readily available to the public. Both new and, since the TCJA, used property can qualify, but used property must not have been previously used by the taxpayer or acquired from a related party.
Another classification is “qualified improvement property” (QIP), which is any improvement made by the taxpayer to the interior portion of a nonresidential building after it was first placed in service. QIP includes upgrades to lighting or flooring but does not cover enlargements of the building, elevators, or the internal structural framework. To claim the deduction, the property must be “placed in service” during the tax year, meaning it is ready and available for its intended use in the business’s operations.
Interaction with Section 179 Expensing
Businesses have another tool for accelerating deductions called Section 179 expensing. While it also allows for the immediate write-off of asset costs, it operates under different rules than bonus depreciation, and understanding these differences is important as bonus depreciation phases out.
A primary distinction lies in the deduction limitations. For 2024, Section 179 has an annual deduction limit of $1.22 million. It also has a total investment phase-out threshold, which for 2024 begins to reduce the available deduction once a business places more than $3.05 million of qualifying property in service. Bonus depreciation has no annual deduction limit or investment spending cap.
Another difference is the income limitation. The Section 179 deduction cannot exceed the business’s net taxable income for the year and cannot be used to create or increase a net operating loss (NOL). Bonus depreciation has no such restriction and can be used to generate a loss that can be carried forward. Section 179 is considered a permanent part of the tax code, with its limits indexed for inflation, whereas bonus depreciation is on a scheduled path to expiration.
IRS rules require that Section 179 be applied first. A business might use Section 179 to expense up to the annual limit on certain assets. For any remaining cost on those assets or for other eligible assets acquired during the year, the business can then apply the current year’s bonus depreciation percentage.
State Tax Treatment Considerations
A business’s federal tax return is the starting point for its state return, but states are not required to adopt all federal tax rules. This concept is known as “conformity,” and many states choose not to conform to the federal bonus depreciation rules, a practice called “decoupling.” This decoupling creates a difference between federal and state taxable income. A business claiming a large federal deduction may have to add that deduction back on its state return, resulting in a higher state taxable income and a potentially unexpected tax bill.
State approaches vary widely. Some states fully conform to the federal rules, while others completely disallow it, requiring assets to be depreciated over their normal lifespan. A third group of states partially conforms, perhaps allowing a deduction at a different percentage than the federal rate. Because these rules differ and can change, businesses must check the specific regulations for every state in which they have a tax filing obligation.