Sept. 13, 2021
Bonus depreciation is a nice tax perk that allows businesses to accelerate tax savings when buying new and used machinery.
Machinery buyers and sellers are critical parts of our economy - machinery enables us to produce food, build infrastructure, homes and offices, and move materials more efficiently. Machinery investments are a core reason why our productivity is high.
Congress knows that investment in capital goods (machinery) and research and development is a key driver of long-term economic growth - as a result, both categories receive preferential tax treatment.
Bonus depreciation is a way to encourage buyers of heavy machinery to continue investing in a fresh and productive fleet.
Under the current IRS guidelines for bonus depreciation, qualified property is defined as tangible personal property with a recovery period of 20 years or less. Most heavy machinery purchases are covered by the current tax law - this includes tractors, combines, forklifts, excavators, dozers, cranes, aerial work platforms (AWPs), telehandlers, etc.
Used machinery purchases qualify as well, so long as the used machinery purchased was not previously owned by the buyer. The treatment of used machinery purchases changed when the tax law was updated in 2017 - previously used machinery purchases did not qualify.
Bonus depreciation cannot be applied to real estate improvements or land purchases. Also, there are specific limitations for purchases of automobiles.
When the tax law was updated in 2017, Congress updated the treatment of farm equipment. The new law shortened the recovery period for machinery and equipment used in a farming business from seven to five years (for normal tax depreciation, not bonus depreciation). This shorter recovery period, however, doesn’t apply to grain bins, cotton ginning assets, fences, or other land improvements.
Depreciation spreads out the cost of long-term assets over the asset's useful life. Depreciation typically is based on a "depreciation schedule" that determines the amount that is attributable to each time period (for example, 20% in Year 1, 15% in Year 2, etc).
Businesses that use US GAAP accounting typically have two depreciation schedules - "book depreciation" and "tax depreciation". Book depreciation is used for business financial reporting and it is typically a smoother depreciation rate (equal amounts each year). Business managers and bankers typically reference book depreciation. Tax depreciation is a different calculation used only for tax purposes. Tax accounting is different than book accounting because tax laws change, and tax laws will often allow for accelerated depreciation.
The calculation in 2021 is fairly simple - 100% of the qualifying asset's value. The calculation can differ when you apply other tax incentives such as Section 179 (see below). Typically tax professionals recommend using the full qualifying Section 179 amount, then applying bonus depreciation to the remaining balance.
The taxpayer may elect out of the additional first-year depreciation for the taxable year the property is placed in service. If the election is made, it applies to all qualified property that is in the same class of property and placed in service by the taxpayer in the same taxable year.
Currently, the bonus depreciation amount is 100% of the asset's value. The percentage changes over time as tax laws evolve. The current rate is scheduled to phase down in the future, however, new laws could likely be passed which maintain the high bonus depreciation rate. Typically Congress reviews tax laws each year and modifies them.
The current tax law schedule for bonus depreciation is as follows:
Example 1: You purchase a used Caterpillar 301.8 mini excavator for $25,000. You did not own this machine in the past, and you will use this machine for business purposes. The qualifying bonus depreciation that year is the full $25,000. Used equipment qualifies for the bonus depreciation as long as you did not own it previously and it is used for business purposes.
Example 2: You purchase a new HLA Attachment for $3,000 for your business. The full amount qualifies for bonus depreciation. Attachments and other items used in combination with your machinery qualify too.
Example 3: You purchase a used John Deere 100 series lawn tractor for $1,200. You will use it 90% of the time for your home residence, and 10% of the time for work purposes. In this instance, the purchase does not qualify because it is primarily used for personal purposes.
Example 4: You purchase a used Volvo Construction Equipment dozer for $60,000. Your business qualified for Section 179 and you used Section 179 to cover the dozer cost. You cannot use bonus depreciation for the dozer since you elected to use Section 179.
Example 5: You purchase a used Peterbilt heavy-duty truck for $110,000. That year you also purchased an International heavy-duty truck and elected not to apply bonus depreciation to the International truck. Since the two assets are similar and purchased in the same year, you must treat the two the same when applying bonus depreciation. As a result, the Peterbilt heavy-duty truck will not qualify for bonus depreciation.
Section 179 deduction and bonus depreciation are both similar ways to reduce your tax bill - both items are IRS rules that determine how you treat your machinery purchases for tax purposes, and both items change over time as the IRS and Congress modify the rules.
So what’s the difference? Section 179 deduction allows taxpayers to deduct the cost of qualifying purchases as an expense rather than capitalizing the asset and depreciating it. This nuance is important for tax accounting - long-lived assets that can be used for many years are typically treated differently than items that have a short life. For example, a new $300,000 Case IH tractor could have a useful life of more than 50 years if you take good care of it (hence it's a long-lived asset), but the DEF fluid you put in the tractor has a short useful life because it is consumed quickly (expense).
Under normal IRS rules without bonus depreciation and Section 179, long-lived assets are typically depreciated over time for tax purposes. In the example above, only a portion of the $300,000 upfront purchase cost can be deducted each year (see MACRS depreciation). Section 179 and bonus depreciation are ways to speed up the deductions and receive tax write-offs faster. Tax deductions received sooner are more valuable than tax deductions received later because a dollar now can be reinvested and earn a return or interest over time.
In 2021 bonus depreciation and Section 179 are more similar than they had been in the past because the bonus depreciation coverage is 100%. In the past when bonus depreciation was limited to 50% of an asset’s cost upfront there were bigger differences for the taxpayer.
You can use a combination of Section 179 and bonus depreciation in a given year. Typically tax professionals recommend using the full qualifying amount for Section 179 first, then applying bonus depreciation to the remaining balance.
Primary differences between Section 179 and bonus depreciation include:
We wrote this blog post to help you better understand bonus depreciation and how it applies to buying machinery. We are not tax experts, nor are we licensed to provide tax advice. You should always consult a professional tax accountant for all matters regarding your taxes. We cannot be held accountable or responsible for your tax matters.
Laws change over time, and so do interpretations of the law. Tax professionals follow these changes and will help you navigate the legislative environment.