TCJA Bonus Depreciation: Rules and Phase-Out

Bonus depreciation is a method of accelerated depreciation that allows businesses to deduct a significant portion of the cost of certain assets in the first year they are placed in service. This tax incentive is designed to encourage businesses to invest in new equipment and other qualifying property. The Tax Cuts and Jobs Act (TCJA) of 2017 introduced changes to the bonus depreciation rules, intended to stimulate economic activity. By allowing a larger upfront deduction, the law aimed to improve cash flow for companies, which could then be reinvested into their operations. Understanding the TCJA’s framework is important for any business making capital expenditure decisions, as its provisions directly impact tax deductions.

Core Bonus Depreciation Changes Under the TCJA

The Tax Cuts and Jobs Act of 2017 brought two main changes to bonus depreciation for assets placed in service after September 27, 2017. The most prominent change was the increase of the additional first-year depreciation deduction from 50% to 100%. This meant businesses could immediately write off the entire cost of eligible property in the year of acquisition and use, rather than depreciating it over several years. This immediate expensing simplified tax calculations and provided a clear incentive for businesses to accelerate planned purchases and boost capital expenditures.

The second change was the expansion of bonus depreciation eligibility to include used property, which was previously restricted to new assets. The TCJA stipulated that used property could qualify for 100% bonus depreciation as long as it was not acquired from a related party or a predecessor business. This opened the tax benefit to a wider range of business acquisitions, including for companies that rely on the second-hand market. For a used asset to be eligible, the taxpayer could not have had a prior ownership interest in the property at any time.

Eligible Property for Bonus Depreciation

For an asset to be eligible for bonus depreciation, it must fall into specific categories defined by the tax code. The primary category is property under the Modified Accelerated Cost Recovery System (MACRS) with a recovery period of 20 years or less. This encompasses a wide array of common business assets, including business vehicles, office furniture, manufacturing equipment, and computer hardware. Beyond tangible property, certain intangible assets also qualify, such as off-the-shelf computer software. The rules also extend to specific types of productions, like qualified film, television, and live theatrical productions, as well as water utility property.

Another category of eligible property is Qualified Improvement Property (QIP). QIP refers to any improvement made by the taxpayer to the interior portion of a nonresidential building, as long as the improvement is placed in service after the building itself. This can include upgrades to lighting, flooring, or internal walls. Expenditures for the enlargement of a building, any elevator or escalator, or the internal structural framework of a building do not qualify as QIP. Due to a drafting error in the TCJA, QIP was initially ineligible for bonus depreciation, but the Coronavirus Aid, Relief, and Economic Security (CARES) Act of 2020 retroactively corrected this, making QIP eligible.

The Bonus Depreciation Phase-Out Schedule

The 100% bonus depreciation rate is not permanent and is being phased out by 20 points each year for property placed in service after 2022. This requires businesses to plan their capital expenditures to take advantage of the higher rates before they expire. The phase-down schedule is as follows:

• Property placed in service in 2023: 80%
• Property placed in service in 2024: 60%
• Property placed in service in 2025: 40%
• Property placed in service in 2026: 20%

Barring new legislation, the bonus depreciation rate will be 0% for property placed in service on or after January 1, 2027.

A special rule applies to certain property with longer production periods and for aircraft. For these specific types of assets, the phase-down schedule is delayed by one year. This means that such property placed in service in 2027 is still eligible for a 20% bonus depreciation deduction. This exception provides an extended window for businesses involved in long-term manufacturing projects.

Claiming Bonus Depreciation and State Tax Considerations

Claiming bonus depreciation is the default treatment for qualifying property for federal tax purposes. Businesses are not required to make a special election to take the deduction. If a business wishes to forgo bonus depreciation for a particular class of assets, it must actively file an election to “elect out” of the provision for that tax year. The deduction is calculated and reported on IRS Form 4562, Depreciation and Amortization, which is filed with the business’s annual income tax return under Section 168(k) of the Internal Revenue Code.

A complexity arises when considering state income taxes, as many states do not conform to the federal tax code for bonus depreciation. A large number of states have “decoupled” from the federal rules, meaning they do not allow for the same accelerated deduction, while some may allow a partial bonus deduction. This lack of conformity creates a compliance burden, as a business must maintain two separate depreciation schedules: one for federal and another for state tax purposes. This divergence results in different taxable income figures at the federal and state levels and requires careful record-keeping.