Article Highlights:
The restoration of bonus depreciation is an important component of recent US tax policy aimed at stimulating economic growth. The 2017 Tax Cuts and Jobs Act (TCJA) previously emphasized bonus depreciation, but its permanent reinstatement at 100% under the "One Big Beautiful Bill Act" underscores its relevance even more, especially given the pandemic's economic repercussions. This article investigates the tax benefits, historical context, applicability, and precise regulations governing bonus depreciation, concluding with an overview of the most recent revisions to its restoration.
Bonus depreciation was first established in 2002 as part of the Job Creation and Worker Assistance Act, allowing businesses to instantly deduct a significant portion of the cost of eligible property rather of having to recoup the cost over time through depreciation. The deduction was initially fixed at 30%, but was later extended to 50% and then to 100% during severe economic downturns.
The TCJA drastically impacted bonus depreciation by allowing a 100% first-year deduction for qualifying property, providing a major incentive for firms. This clause was intended to promote capital acquisition and economic growth. However, the TCJA included a sunset provision that began phasing away the bonus depreciation rate in 2023, with no bonus depreciation allowed by 2027.
Bonus depreciation allows firms to fully deduct the cost of assets in the year they are put into service, resulting in immediate tax reduction and increased investment. This advantage increases a company's cash flow by lowering taxable income, offering it a strong incentive to buy new assets.
However, using bonus depreciation successfully necessitates careful preparation. For example, the Section 199A deduction is dependent on qualified business income (QBI), therefore deducting big capital purchases might diminish an entity's profit, lowering the Sec 199A deduction. In contrast, lowering taxable income may assist avoid some 199A phase-outs and limitations.
Qualifying property often includes tangible property with a 20-year recovery time or less, computer software, water utility property, and qualified renovations and productions. The IRS sets recovery periods. For example, most business vehicles have a five-year recovery term, whereas most office equipment has a seven-year recovery period. Real property does not qualify for bonus depreciation because the recovery period ranges from 27.5 to 39 years, depending on how the property is used.
The TCJA broadened the definition of qualified property to cover both new and old qualifying property, increasing the appeal of investing in used equipment. Public utility facilities and dealership properties relating to autos are specifically prohibited, adding another layer of complexity.
Legislative hurdles arose initially for qualified improvement properties. The TCJA intended to integrate properties such as leasehold, restaurant, and retail renovations into a category eligible for bonus depreciation during a 15-year MACRS recovery period. However, a mistake initially excluded these assets, which was later addressed by the CARES Act.
Typically, opting out of bonus depreciation can only be revoked with IRS agreement if done on a timely filed return, with revocation allowed within six months on revised returns. One notable benefit is that property with claimed bonus depreciation is excluded from alternative minimum tax (AMT) adjustments, bringing AMT depreciation relief in line with ordinary tax purposes.
Special rules and deduction limitations apply to corporate vehicles classified as "luxury autos." The depreciation ceiling is increased by $8,000 in years where bonus depreciation is available, as specified by the TCJA. It is not addressed in OBBBA, so it is expected that the additional amount will remain.
Related party regulations, as well as the implementation of Section 179, which requires pre-bonus depreciation adjustments, complicate matters even more. (Section 179 allows you to write off the acquisition of some business property without having to depreciate it, but the deduction must be reclaimed if business use reduces to 50% or less in the year after the asset is placed in service.)
The OBBBA restoration extends the 100% deduction to qualifying property purchased and brought into service after January 19, 2025. OBBBA has made bonus depreciation permanent. The bonus depreciation rate for qualified property placed in service between January 1, 2025 and January 19, 2025 continues at 40%.
This consistency gives businesses long-term planning capacity and aligns investments with broader economic policies aimed at boosting growth.
The "One Big Beautiful Bill Act" also included a measure to boost manufacturing in the United States. Pre-OBBBA law obliged taxpayers to deduct (depreciate) the cost of business-related nonresidential real property over a 39-year period. Bonus depreciation was mainly limited to tangible personal goods rather than real estate.
Effective for property placed in service after July 4, 2025, OBBBA usually permits taxpayers to deduct 100% of the cost of certain new factories, renovations to existing factories, and other structures. This provision permits taxpayers to deduct 100% of the adjusted basis of qualified producing property in the year it is placed into operation.
Qualified Production Property refers to selected areas of nonresidential real property that meet the following criteria:
Even though manufacturing machinery that does not qualify as qualified production property is not expensed under this clause, it is often eligible for 100% bonus depreciation, as reintroduced by OBBBA.
In general, a "qualified production activity" is defined as follows:
1. Activities Involved: It refers to the creation, manufacture (limited to agricultural and chemical production), or refinement of a qualified product. These efforts should result in a significant transformation of the property that comprises the product.
2.Qualified Product: A qualified product is any tangible personal property that is not a food or beverage manufactured in the same facility as the retail business where it is sold.
In summary, for an activity to qualify under this clause, it must entail major production or transformation activities, with the exception of some agricultural and chemical productions.
Recapture regulations apply in some circumstances where the use of qualifying production property changes within the 10-year period following its placement in service. When the property is sold, to the amount of the bonus depreciation taken, any gain will be ordinary income rather than capital gain;
The reintroduction of bonus depreciation is a critical instrument for economic revitalization, giving businesses with immediate tax breaks to undertake capital investments. While it has significant advantages, understanding the complexity and strategizing around QBI deductions, AMT ramifications, and specific qualifications is critical. Despite legislative intricacies and phased-out restrictions, bonus depreciation remains a critical component in strategic corporate planning for long-term economic development. The addition of qualifying production property creates a significant incentive for developing production facilities in the United States. While often regarded of as a deduction for large corporations, it can also apply to small manufacturing operations.
If you are a business owner and have concerns regarding how Bonus Depreciation can assist your company, please contact our office.