What Is 100 Percent Bonus Depreciation?

Bonus depreciation is a tax incentive that allows a business to deduct a large percentage of an eligible asset’s cost in the first year it is used. This accelerated deduction, instead of being spread over the asset’s useful life, can reduce a company’s taxable income and lower its immediate tax liability, encouraging investment in new and used assets.

The Tax Cuts and Jobs Act of 2017 (TCJA) expanded this incentive, most notably by increasing the allowable first-year deduction to 100 percent for a period of time. This increased the rate from the 50 percent bonus depreciation that was previously available. This upfront deduction provides an immediate cash flow benefit, helping businesses grow by investing in equipment and other assets.

Determining Asset Eligibility

An asset must fall into specific categories to qualify for bonus depreciation. The most common is Modified Accelerated Cost Recovery System (MACRS) property with a recovery period of 20 years or less. This includes business assets like machinery, equipment, furniture, fixtures, and certain vehicles. Most tangible business property, other than real estate, is eligible.

The TCJA expanded bonus depreciation to include used property. For used property to qualify, the taxpayer cannot have used the property before acquiring it. It also cannot have been acquired from a related party or a component member of a controlled group.

Computer software is also an eligible property category. To qualify, software must be readily available for public purchase, subject to a non-exclusive license, and not substantially modified. This allows businesses to deduct the cost of many common software programs.

Qualified Improvement Property

Qualified Improvement Property (QIP) is an asset type eligible for bonus depreciation. QIP is any improvement a taxpayer makes to the interior of a nonresidential building after the building was first placed in service. Examples of QIP include:

• New drywall
• Ceilings
• Interior doors
• Fire protection systems
• Electrical or plumbing systems

QIP does not include expenditures for enlarging the building, elevators, escalators, or the internal structural framework. The CARES Act of 2020 made a technical correction to the TCJA, assigning a 15-year recovery period to QIP. This change retroactively made it eligible for 100 percent bonus depreciation and particularly benefited businesses in the retail, restaurant, and hospitality industries.

The Bonus Depreciation Phase-Down

The 100 percent bonus depreciation rate from the TCJA is not permanent and is subject to a scheduled phase-down. The rate was 100 percent for property placed in service after September 27, 2017, and before January 1, 2023. The rate decreases for property placed in service in subsequent calendar years:

• 2023: 80 percent
• 2024: 60 percent
• 2025: 40 percent
• 2026: 20 percent

After 2026, bonus depreciation is scheduled to be eliminated. Businesses should monitor legislative developments, as Congress has shown support for restoring the 100 percent deduction, which could impact future capital expenditure planning.

Claiming or Electing Out of Bonus Depreciation

Claiming bonus depreciation is the default treatment for eligible property. The IRS assumes a business will take the deduction unless it formally elects out. It is automatically applied when calculating depreciation on Form 4562, Depreciation and Amortization, so no special election is needed to claim it.

A business may elect out of bonus depreciation for strategic reasons, such as spreading deductions into future years when anticipating a higher tax bracket. This election is made on a class-by-class basis. For example, a business can opt out for all its 5-year property while still claiming bonus depreciation for its 7-year property.

To elect out, a taxpayer must attach a statement to their timely filed federal income tax return for the year the property is placed in service. The statement must indicate the taxpayer is electing out of the additional first-year depreciation deduction. It must also identify the class or classes of property for which the election is being made. Once made for a property class, the election is irrevocable.

State Tax Treatment Considerations

State income tax laws do not always follow federal rules for bonus depreciation. State tax code “conformity” with the federal Internal Revenue Code varies. Some states have rolling conformity and automatically adopt federal changes, while others have static conformity, tying their laws to the IRC as of a specific date and ignoring recent updates.

Many states have “decoupled” from the federal bonus depreciation rules and do not allow the accelerated deduction. In these states, businesses must calculate depreciation using standard MACRS schedules for state tax purposes. This results in a discrepancy between federal and state taxable income, with state income often being higher when an asset is acquired.

This lack of conformity requires businesses to maintain separate depreciation records for federal and state tax returns. This can result in a higher state tax liability in the first year of an asset’s life. The additional state tax paid is recovered through larger state depreciation deductions in later years, creating a timing difference that businesses must manage.