Can You Take Bonus Depreciation If You Have a Loss?

Bonus depreciation is a tax incentive that allows businesses to deduct a large percentage of an asset’s cost in the year it is placed into service rather than spreading the deduction over several years. This can provide significant tax savings, but its benefits depend on a company’s financial situation, including whether it has taxable income or is operating at a loss.

Asset Requirements

To qualify for bonus depreciation, an asset must meet IRS criteria under Section 168(k) of the Internal Revenue Code. The property must be tangible personal property with a recovery period of 20 years or less, covering machinery, equipment, furniture, and certain leasehold improvements. Real estate, such as buildings and land, does not qualify unless specific improvements, like roofing or HVAC systems, meet eligibility requirements.

The asset must be new to the taxpayer, though it does not have to be brand new. The Tax Cuts and Jobs Act of 2017 expanded eligibility to include used property, provided it was not previously owned by the same taxpayer. Property acquired from a related party or received as a gift or inheritance does not qualify.

Timing is also critical. The asset must be placed in service during the tax year to claim bonus depreciation. Simply purchasing the asset is not enough; it must be ready and available for use. For example, if a company buys equipment in December but does not install it until January, the deduction applies to the following tax year.

Interaction with Net Operating Loss

Bonus depreciation can significantly reduce taxable income, but if a business already has a net operating loss (NOL), its immediate benefit is limited. Since bonus depreciation lowers taxable income, claiming it in a loss year increases the NOL rather than providing immediate tax relief.

Under current tax laws, NOLs can be carried forward indefinitely but cannot be carried back. They can offset up to 80% of taxable income in future years. For example, if a business incurs a $500,000 NOL in 2024 due to bonus depreciation and generates $600,000 in taxable income in 2025, only $480,000 (80%) can be offset, leaving $120,000 subject to tax.

The decision to take bonus depreciation in a loss year should consider the time value of money. If a business expects to be profitable soon, deferring depreciation through regular MACRS deductions instead of electing bonus depreciation may be more strategic. This allows for deductions in years when they provide immediate tax benefits rather than increasing an NOL that can only be used incrementally.

Passive vs. Nonpassive Activity

The effectiveness of bonus depreciation depends on whether the activity generating the depreciation is classified as passive or nonpassive under IRS rules. Passive losses, including those from depreciation, can only offset passive income, while nonpassive losses can offset all types of income.

Passive activities generally include rental real estate or businesses where the owner does not materially participate. For example, if an individual owns a rental property and claims bonus depreciation on improvements, the resulting loss is typically passive. Unless they have other passive income, such as rental earnings from another property or profits from a limited partnership, the deduction may be suspended and carried forward.

Nonpassive activities include businesses in which the taxpayer materially participates, meaning they meet one of the IRS’s seven material participation tests under Treasury regulations. If bonus depreciation is claimed in an active trade or business where the taxpayer is significantly involved, the deduction can offset any type of income. For example, a sole proprietor running a retail store full-time could use bonus depreciation on new equipment to reduce taxable income from the business or offset other earnings, such as wages from a separate job.

Tax Liability Calculations

Maximizing the tax benefits of bonus depreciation requires understanding how it impacts taxable income and overall liability. Since this deduction directly reduces taxable income, it can push a business into a lower tax bracket. For example, a corporation with $500,000 in taxable income taxed at the 21% federal corporate rate would owe $105,000 in taxes. If it claims $200,000 in bonus depreciation, taxable income drops to $300,000, reducing the tax liability to $63,000—a $42,000 tax savings.

Bonus depreciation also affects estimated tax payments. The IRS requires businesses to make quarterly payments based on expected annual liability. A large deduction early in the year may lower required payments, improving cash flow. However, miscalculating the impact could lead to underpayment penalties if taxable income is higher than projected. Companies using the annualized income installment method under IRS rules can adjust payments throughout the year to avoid penalties.

State tax treatment adds another layer of complexity. Some states, such as California and New York, do not conform to federal bonus depreciation rules, requiring businesses to add back the deduction when calculating state taxable income. This can result in higher state taxes even if federal liability decreases, making multi-jurisdictional planning essential.

Depreciation Recapture

While bonus depreciation provides significant upfront tax savings, it can trigger depreciation recapture if the asset is later sold or disposed of. Recapture rules require businesses to report previously deducted depreciation as ordinary income, potentially increasing tax liability in the year of sale.

For tangible personal property, such as machinery or equipment, depreciation recapture falls under Section 1245 of the Internal Revenue Code. If an asset is sold for more than its adjusted basis—original cost minus accumulated depreciation—the excess depreciation claimed is taxed as ordinary income rather than at lower capital gains rates. For example, if a business purchases equipment for $100,000 and claims $80,000 in bonus depreciation, the adjusted basis drops to $20,000. If the equipment is later sold for $70,000, the $50,000 difference is subject to ordinary income tax rates.

Real property follows different recapture rules under Section 1250, but since most real estate does not qualify for bonus depreciation, this is less of a concern. However, leasehold improvements that were eligible for bonus depreciation may be subject to recapture if sold or abandoned before the end of their useful life. Businesses should consider the long-term implications, especially if they anticipate selling assets soon. Proper tax planning can help mitigate unexpected liabilities by timing asset sales strategically or utilizing like-kind exchanges under Section 1031 to defer recognition of recapture income.