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Unlocking Bonus Depreciation is a great way to release additional cashflow during a time where access to capital is crucial. Interested in understanding how this accounting mechanism works? Read on here to learn more.
What is Depreciation?
Put simply, assets degrade over time. The value of that degradation is what is referred to in accounting as depreciation.
At the time of purchase, an asset’s value is still worth its purchase price and so can’t be immediately expensed. However, the asset’s annual depreciation value is considered a business expense and is called a depreciation deduction.
Depreciation deduction amounts depend on the value of the individual asset and the class life it sits in. For example:
Asset
Value
Class Life
Year 1 Depreciation Deduction (Value/Life)
Building
$1,000,000
39 years
$25,641
Vehicle
$30,000
5 years
$6,000
Total
$31,641
What is Bonus Depreciation?
Bonus depreciation offers an additional first year depreciation deduction for certain assets, generally with a class life of 20 years and less.
Bonus depreciation rules have fluctuated since its inception but have generally remained at 50% of the asset’s cost. For assets placed in service after September 27th, 2017, however, the bonus depreciation allowance increased to 100%, turning the table above into the below:
By understanding and correctly utilizing bonus depreciation, depreciation deductions in one year increased by $24,000.
Extrapolated across a full depreciation schedule, the benefits of bonus depreciation are clear. It has a significant impact not only on a company’s tax liability, but on the availability of cash that can be reinvested into the business.
Bonus Depreciation Rules are Changing Again
Starting in 2023, the Tax Cuts and Jobs Act of 2017reduces the bonus depreciation rate by 20% annually. Consequently, assets placed into service in 2023 depreciate at 80%, 60% in 2024, and so forth.
The reduction will gradually limit bonus depreciation benefits. However, assets placed in service between 2017 and 2023 can still qualify for 100% bonus depreciation retroactively.
Companies can modify their accounting method using Form 3115. This allows them to claim proper depreciation for assets previously placed in service. They can then catch up on that depreciation when they file their next tax return.
Using this method, assets placed in service between 2017-2023 still qualify for 100% bonus depreciation, and no tax return amendments are needed.
Cost Segregation and Bonus Depreciation
Cost Segregation is a detailed, engineering-based process of methodically separating personal property and land improvements from a building’s structural assets.
Given that personal property are generally depreciated over five or seven years, and land improvements over 15, this makes them eligible for bonus depreciation.
By conducting a cost segregation study, acquisition or construction costs can be pulled out of the 27.5- or 39-year asset classes and depreciated at their full value right away.
Want to learn more about Cost Segregation and bonus depreciation? Reach out to Leyton’s tax and engineering experts for a discussion today.
