What Were the Rules for 2021 Bonus Depreciation?

Bonus depreciation is an accelerated depreciation method allowing businesses to deduct a significant portion of an asset’s cost in the year it is placed in service. For the 2021 tax year, rules established by the Tax Cuts and Jobs Act (TCJA) allowed for a 100% first-year deduction for qualifying business property. This incentive was designed to encourage businesses to invest in new and used assets.

Determining Property Eligibility for 2021

For an asset to be eligible for bonus depreciation in 2021, it needed to be tangible personal property with a Modified Accelerated Cost Recovery System (MACRS) recovery period of 20 years or less. This category includes a wide range of business assets such as machinery, equipment, vehicles, furniture, and computer software.

A significant aspect of the 2021 rules was the inclusion of used property. For 2021, a business could claim the deduction on used property, provided certain acquisition requirements were met. The taxpayer could not have used the property before acquiring it, nor could they have acquired it from a related party, such as a family member or a controlled business entity.

Certain property types were explicitly excluded from bonus depreciation eligibility. This included land, which is not depreciable, and property used predominantly outside the United States. Additionally, assets with very long production periods or those used by certain regulated public utilities were not eligible for the deduction.

Qualified Improvement Property

Qualified Improvement Property (QIP) refers to certain improvements made to the interior of a nonresidential building after the building was first placed in service. Due to a drafting error in the TCJA, QIP was initially assigned a 39-year recovery period, making it ineligible for bonus depreciation.

The Coronavirus Aid, Relief, and Economic Security (CARES) Act included a technical correction that retroactively changed the recovery period for QIP to 15 years. This correction made QIP placed in service from 2018 through 2021 eligible for 100% bonus depreciation.

Calculating and Claiming the Deduction

For qualified property acquired and placed in service during 2021, the bonus depreciation rate was 100%. This allowed a business to deduct the entire cost of an eligible asset in the year of its purchase. The 100% rate was available for property placed in service before January 1, 2023, and is scheduled to phase down: 80% for 2023, 60% for 2024, 40% for 2025, and 20% for 2026.

For example, if a business purchased qualifying equipment for $50,000 and placed it in service during 2021, it could claim a bonus depreciation deduction of $50,000 for that year. This deduction would reduce the asset’s depreciable basis to zero, meaning no further depreciation could be taken on it in subsequent years.

To claim the deduction, taxpayers used Form 4562, Depreciation and Amortization. The total bonus depreciation deduction is reported in Part II on the line designated for the special depreciation allowance for qualified property.

The Process for Electing Out

Taxpayers had the option to elect out of taking 100% bonus depreciation for 2021. A business might choose this path to better align its deductions with its income over time, particularly if it anticipated being in a higher tax bracket in future years. Another reason could be to avoid generating a net operating loss (NOL) or because of complexities arising from state tax laws that do not conform to federal rules.

The election had to be made on a timely-filed federal income tax return for the tax year in which the property was placed in service. To make the election, a taxpayer was required to attach a statement to their return that clearly identified the specific class of property for which the election was being made.

The election was made by property class, not on an individual asset basis. For example, a business could elect out for all of its 5-year property while still claiming 100% bonus depreciation on its 7-year property. Once this election was made, it was irrevocable for that tax year.

State Tax Treatment Considerations

A complication for businesses in 2021 was the varying treatment of bonus depreciation at the state level. While the federal government allowed for a 100% deduction under Internal Revenue Code Section 168, states were not required to adopt the same rules. Many states chose to “decouple” from the federal bonus depreciation provisions, meaning they either completely disallowed the deduction or allowed only a limited portion of it.

This nonconformity had practical consequences for taxpayers. Businesses in decoupling states were required to maintain two separate depreciation schedules: one for their federal return and another for their state return using the state’s prescribed method. This created a difference in the adjusted basis of the asset for federal versus state tax purposes, which had to be tracked over the entire life of the asset to correctly calculate gain or loss upon its eventual sale or disposal.