When a business buys equipment, vehicles, technology, or other long-term assets, the IRS doesn’t typically allow the full cost to be deducted right away. Instead, the expense is spread across multiple years through depreciation. This standard approach helps match the cost of an asset with the revenue it generates over time, but it also delays valuable tax savings.
Bonus depreciation changes that.
Bones depreciation allows businesses to deduct a large portion of an asset’s cost upfront, in the year the asset is placed in service. This accelerated deduction can significantly reduce taxable income, strengthen cash flow, and free up capital for hiring, expansion, or new projects.
In recent years, bonus depreciation has become one of the most widely used tax incentives for small and mid-sized businesses. Under the Tax Cuts and Jobs Act (TCJA), companies enjoyed 100% bonus depreciation from 2017 – 2022. Although the benefit is currently phasing down – 80% in 2023, 60% in 2024, 40% in 2025, and 20% in 2026 – the incentive remains a powerful tool for businesses investing in equipment or upgrades.
By understanding how bonus depreciation works, what qualifies, and how to use it strategically, business owners can make smarter decisions about tax planning and capital investment.
What is Bones Depreciation?
Bones depreciation is a tax incentive that allows businesses to deduct a large percentage of an asset’s cost in the first year it’s placed in service rather than spreading the deduction out over several years. It’s essentially an accelerated form of depreciation designed to encourage investment, expansion, and economic growth.
Under traditional MACRs depreciation rules, a business might deduct the cost of equipment over five, seven or even in some cases ten years. Bonus depreciation speeds this up, allowing a significant portion of the expenses to be taken immediately. This upfront deduction can reduce a business’s taxable income for the year of purchase, resulting in a lower tax bill and stronger cash flow.
Bonus depreciation is outlined under IRS Section 168(k), which sets the rules for which assets qualify, how much can be deducted each year, and how the phasedown schedule works. Unlike other tax incentives, such as Section 179, bonus depreciation does not have an annual spending cap and does not require the business to be profitable to take the deduction. In many cases, bonus depreciation can even create a net operating loss that can be carried forward.
In short, bonus depreciation gives businesses the ability to recover the cost of equipment and other qualifying assets faster, freeing capital during key growth periods.
How Business Depreciation Works
Bonus depreciation lets a business deduct a large portion of an asset cost up front, but several rules determine how the deduction is applied. Understanding these basics helps business owners plan purchases strategically and time deductions for maximum tax benefit.
Immediate First-Year Deduction
With bonus depreciation, a business can deduct a set percentage of an asset’s purchase price in the same year it’s placed in service. For assets purchased today, this percentage follows the IRS phase-down schedule:
- 2023: 80%
- 2024: 60%
- 2025: 40%
- 2026: 20%
- 2027 and beyond: Scheduled to return to standard depreciation unless Congress extends the program.
The remaining cost (the portion not taken as a bonus depreciation) is depreciated normally over the asset’s useful life using MACRS rules.
This structure gives businesses a powerful way to reduce taxable income in high-expense or high-investment years.
Eligible Property Requirements
To qualify for bonus depreciation, the asset must meet IRS criteria:
- Useful life of 20 years or less: e.g., machinery, equipment, vehicles, computers, tools, furniture.
- New or used property: As long as the taxpayer did not previously own or use the asset.
- Qualified Improvement Property (QIP): Improvements to the interior of nonresidential buildings also qualify.
- Placed in service within the tax year: Simply purchasing an asset is not enough; it must actually be ready to use.
This flexibility allows businesses across all industries to benefit.
What Doesn’t Qualify
Certain assets cannot be depreciated using bonus depreciation, including:
- Land and buildings
- Assets used outside of the United States
- Inventory
- Property financed through certain tax-exempt structures.
These limits ensure bonus depreciation primarily supports business investment, not real estate speculation or inventory purchases.
Example: How Bonus Depreciation is Applied
Imagine a business purchases $100,000 of equipment in 2025, when bonus depreciation allows a 40% deduction.
- Bonus depreciation deduction: $100,000 x 40%= $40,000
- Remaining depreciable basis: $100,000 – $40,000= $60,000
- This amount is then depreciated over the asset’s normal MACRS schedule.
By taking $40,000 upfront, the business reduces its 2025 taxable income immediately while still capturing long-term depreciation benefits.
Bonus Depreciation vs. Section 179: What’s the Difference?
Bonus depreciation and Section 179 are two of the most powerful tax incentives available to business owners, and while they often work together, they operate very differently. Understanding how each one works helps businesses choose the strategy that delivers the greatest tax benefit.
Key Differences Between Bonus Depreciation and Section 176
- Deduction Limits: Section 179 has an annual spending cap, which starts phasing out once total equipment purchases exceed a set threshold. Bonus depreciation has no dollar limit, allowing businesses to deduct large purchases, even millions of dollars, in a single year.
- Profitability Requirements: Section 179 cannot exceed taxable income. A business must be profitable to fully use the deduction. Bonus depreciation can create a loss, which can be carried forward to future years.
- Election vs. Automatic Application: Section 179 must be explicitly elected on a tax return. Bonus depreciation applies automatically unless a business chooses to opt out.
- Eligible Property: Section 179 covers many of the same assets as bonus depreciation but includes additional categories such as certain real property improvements. Bonus depreciation applies broadly to assets with a useful life of 20 years or less, including qualified improvement property (QIP).
- Treatment of New vs. Used Assets: Both incentives allow deductions for new and used equipment, but Section 179 has more specific restrictions or related-party purchases.
When to Use Section 179 vs. Bonus Depreciation
When Section 179 is Better
- Your business wants to control exactly which assets receive first-year deductions.
- You’re purchasing lower-cost equipment that doesn’t exceed the spending cap.
- You want to deduct improvements to nonresidential property that may not qualify for bonus depreciation.
- You want to avoid creating a new operating loss and prefer to stay within taxable income limits.
When Bonus Depreciation is Better
- You’re making large purchases or acquiring in bulk.
- You want to take a substantial deduction upfront without worrying about caps.
- Your business is experiencing a high-growth year and needs maximum cash flow.
- You aren’t profitable but still want to benefit from immediate depreciation.
- You want a simpler option that applies automatically
Using Both Together
Many businesses use Section 179 first, then bonus depreciation to any remaining costs. This creates the most flexible and tax-efficient structure, especially in years with multiple asset purchases.
Advantages and Disadvantages of Bonus Depreciation
Bonus depreciation is one of the most valuable tax income incentives to small and mid-sized businesses, but like any powerful tool, it has both strengths and limitations. Understanding the trade-offs helps business owners decide whether accelerating deductions align with long-term financial strategy.
Advantages of Bonus Depreciation
- Immediate Tax Savings: Instead of spreading deductions over several years, bonus depreciation allows a business to take a large deduction upfront. This can significantly reduce taxable income in the year of purchase.
- Stronger Cash Flow: Lower taxes mean more liquidity. Businesses can redirect these savings toward payroll, inventory, equipment, marketing, or new projects. This is especially helpful during periods of expansion.
- No Annual Spending Caps: Unlike Section 179, bonus depreciation has no limit on the amount you can deduct. Whether you buy $50,000 or $5 million worth of equipment, eligible assets can receive the same accelerated treatment.
- Works for Profitable and Unprofitable Businesses: Bonus depreciation can create or increase a net operating loss (NOL), which can be carried forward. This flexibility allows struggling or newly launched businesses to still benefit.
- Encourages Business Investment: Because the deduction is taken immediately, bonus depreciation often motivates companies to invest sooner in equipment, technology upgrades, vehicles, or facility improvements.
Disadvantages of Bonus Depreciation
- Fewer Deductions in Future Years: Taking a large upfront deduction means smaller (or no) depreciation deductions later. Businesses expecting higher taxable income in future years may prefer to stretch the deduction instead of accelerating it.
- Not Always Ideal for Long-Term Planning: If a company anticipates entering a higher tax bracket later, saving deductions for those years may be more strategic than front-loading everything now.
- Eligibility Restrictions: Although flexible, bonus depreciation does not apply to real estate, land improvements, or certain property types. Misclassifying assets can lead to tax issues.
- Phase-Down Reduces Impact: The IRS phase-down (100% → 80% → 60% → 40% → 20%) means the immediate deduction is shrinking each year unless Congress extends or reinstates higher percentages.
Key Takeaways
Bonus depreciation remains one of the most powerful tax incentives available to businesses investing in equipment, technology, or operational upgrades. By allowing a large portion of an asset’s cost to be deducted upfront, it provides immediate tax relief and strengthens cash flow, two advantages that can make a meaningful difference during periods of growth or rising expenses.
Even with the current IRS phase-down schedule, bonus depreciation continues to offer substantial benefits for small and mid-sized businesses that want to recover costs faster and reinvest in their operations. The key is understanding how the rules work, which assets qualify, and how bonus depreciation fits into your broader tax and financial strategy.
Every business has different goals, profitability levels, and timing needs; it’s always wise to work with a CPA or tax professional to determine the most effective approach. When used strategically, bonus depreciation can be a valuable tool for managing cash flow, planning investments, and supporting long-term business growth.
