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Taxes: Why Elect Out of the Depreciation Bonus?
Farm Business Management Update, December-January 2002/2003
By Daniel Osborne
As one might expect, the 2002 tax year has new legislation in effect to add to the ever increasingly complex tax law. This new legislation came primarily in the form of the Job Creation and Worker Assistant Act of 2002. The most significant piece of this legislation for the majority of Virginia farmers is the Depreciation Bonus. Businesses are allowed to take an additional 30% in depreciation for new property purchased after September 10, 2001 and before September 11, 2004. Of course, this is subject to several qualifications. The goal of the Depreciation Bonus is to encourage purchasing and thereby create jobs. (For more information on these qualifications, see the instructions to Form 4562.) If you have purchased new property that meets the qualifications for the Depreciation Bonus, you are required to take the additional 30% depreciation unless you elect out by attaching a statement to your return. Now, the question is why would you elect out of the Depreciation Bonus?
Several reasons come to mind where it may be beneficial to elect out of the depreciation Bonus. The first situation is if you are expecting higher income levels and, therefore, a higher tax rate in the next few years compared to the current year. Electing out will allow you to offset the higher income with more depreciation expense in the later years. If you plan to sell the purchased property in a year in which you are in a higher tax bracket, any depreciation recapture would be taxed at the higher rate. The problem of being in a higher tax bracket for up to two years later can be eliminated by using Schedule J to average income for three years, but this is more of a headache than just electing out of the Depreciation Bonus.
Another situation where electing out may be beneficial is when not electing out is going to cost more in record keeping than it is worth. If you buy $50,000 worth of equipment, you could expect to earn between $200 and $600 in interest from the Depreciation Bonus over the course of seven years by taking the extra depreciation now rather than later. Virginia is not going to allow the Depreciation Bonus in calculating the Virginia income tax. Therefore, if you do not elect out, you will have to calculate depreciation two different ways: one way for federal purposes and another for Virginia. The cost of paying a tax preparer to calculate depreciation two different ways for seven years could easily exceed $200.
Don't think that electing out of the Depreciation Bonus is what I am encouraging everyone to do. As I said, you could expect to earn between $200 and $600 in interest on the early tax savings. You should, however, consider your situation to determine whether electing out is to your advantage.
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FAQs
Electing out will allow you to offset the higher income with more depreciation expense in the later years. If you plan to sell the purchased property in a year in which you are in a higher tax bracket, any depreciation recapture would be taxed at the higher rate.
Why you would opt out of using bonus depreciation? ›
One scenario where electing out of bonus depreciation can be effective is when a business anticipates higher taxable income in future years. By electing out, the business preserves depreciation deductions for future use, which can help offset higher taxable income and potentially reduce tax liabilities in those years.
What happens if you forget to elect out of bonus depreciation? ›
Taxpayers who fail to elect out on their timely filed return or amended return and does not claim bonus depreciation is using an improper accounting method. They need to file Form 3115, Application for Change in Accounting Method, under the automatic consent procedure (accounting method change number 7).
What form do I need to elect out of bonus depreciation? ›
The election must be made by filing a statement with Form 4562, “Depreciation and Amortization,” by the due date, including extensions, of the Federal tax return for the taxable year in which the qualified property is placed in service by the taxpayer.
What are the disadvantages of bonus depreciation? ›
Bonus depreciation has no limitations but may force a company to “waste" depreciation that it could benefit from in future years. Accelerating depreciation also lowers the book value of your assets, which can affect balance sheet ratios that may impact your ability to borrow money.
When should you not take bonus depreciation? ›
The IRS explicitly disqualifies certain types of assets from being able to claim bonus depreciation. Under new bonus depreciation rules, assets are not eligible if they are: Primarily used in the trade of furnishing or sale of electrical energy, water, or sewage disposal services.
Is it better to take bonus depreciation or Section 179? ›
Section 179 has an investment limit of $2,620,000 for 2023, beyond which the deduction starts to phase out. There's no such cap for Bonus Depreciation, making it a better option for businesses making substantial investments in a single year.
Is bonus depreciation being phased out? ›
That maximum benefit, however, expired in 2022, and for tax years beginning after December 31, 2022, the 100% bonus depreciation deduction is phasing out 20% per year until it fully sunsets after the end of the 2026 calendar year.
How do you avoid bonus depreciation recapture? ›
To mitigate the impact of the Depreciation Recapture Tax, taxpayers can explore strategies such as like-kind exchanges (under Section 1031) or investing in Qualified Opportunity Zones. These strategies allow for the deferral or reduction of capital gains taxes, including those related to depreciation recapture.
Can you take bonus depreciation on inherited property? ›
Year of inheritance:
You can have a cost segregation study done and enjoy the similar benefits as if you just purchased or renovated the property. However, inherited property does not qualify for bonus depreciation since you did not purchase it.
They determine that about 20% ($100,000) of the property can be depreciated using 100% first-year bonus depreciation. This increase in depreciation expense causes your current losses to exceed $100,000 and allows you to offset the entire capital gain from sale.
Can you use bonus depreciation to offset w2 income? ›
As of 2023, the law has been phased out to allow 80% accelerated depreciation, down from 100%. Yet, by leveraging bonus depreciation, you could potentially realize losses of over $100,000 in the first year that you could use to offset W-2 income and other forms of income.
How long do you have to keep a vehicle under section 179? ›
The section 179 deduction is only available in the tax year the vehicle is purchased and placed in service for business use, and the vehicle must be used over 50% of the time for business purposes.
Who benefits from bonus depreciation? ›
According to the Internal Revenue Service (IRS), bonus depreciation allows business taxpayers to deduct additional depreciation for the cost of qualifying business property, beyond normal depreciation allowances. It's intended to spur capital purchases by all business taxpayers, small, mid-sized and large.
Does bonus depreciation stimulate the economy? ›
Bonus depreciation is a tax incentive designed to stimulate business investment by allowing companies to accelerate the depreciation of qualifying assets, such as equipment, rather than write them off over the useful life of the asset.
What is the difference between 179 depreciation and bonus depreciation? ›
So what's the difference between Section 179 and bonus depreciation? Section 179 lets business owners deduct a set dollar amount of new business assets, and bonus depreciation lets them deduct a percentage of the cost.
Is bonus depreciation a good idea? ›
Bonus depreciation is an important tax-saving tool for businesses, allowing them to take an immediate deduction on the cost of eligible business property in the first year. This lowers a company's tax liability because it reduces its taxable income.
Should I do bonus depreciation? ›
If you purchase depreciable property in your business, depreciating the property isn't optional–it's required. But bonus depreciation isn't mandatory. If you purchase property that qualifies for bonus depreciation, and for whatever reason don't want to write off 100% of the cost, you can elect not to take it.
What is the effect of using bonus depreciation rather than straight line depreciation? ›
Using bonus depreciation rather than straight line depreciation would normally have no effect on a project's total projected cash flows, but it would affect the timing of the cash flows and thus the NPV.
