2.3.4.4. Bonus Depreciation
Bonus depreciation was first introduced following the attacks of September 11, 2001, as an effort to stimulate a struggling economy. Like the Section 179 deduction, bonus depreciation deducts from taxes the cost of new and used qualified equipment that is purchased and place in service during the tax year. Purchases may be financed or paid for in cash. Qualified capital equipment includes:
• tangible property depreciable for 20 years or less
• computer software
• interior improvements to commercial property
The amount that can be deducted has varied over the years, ranging from 30% to 50% of the asset’s cost. The Tax Cuts and Jobs Act of 2017 increased the size of the deduction to 100%, which will be applied through 2022. Beginning in 2023, the deduction will be reduced by 20% per year until it completely phases out by 2028.
Unlike a Section 179 deduction, bonus depreciation imposes no dollar limit. Nor does the business need to be profitable to qualify for the deduction. Like any depreciable expense, losses may be carried over from year to year. Bonus depreciation, however, is really a tax deferral, not a deduction, making it subject to depreciation recapture and taxable at the ordinary income rate. Since it represents a deferral of taxes, it is allocable to passive investors.
Example: Paramount Offshore Drilling, an income oil and gas DPP, spent $20 million on equipment for three new offshore drilling rigs. Under the new tax law, the company will depreciate the entire amount as an expense in the current tax year. As a limited partner with a 0.1% allocation, Samuel can deduct $20,000 in bonus depreciation from his 2020 gross income, assuming he has passive income of this amount from this and his other investments. Assume the company sells its operation four years later at a $20 million profit. Samuel’s $20,000 share will be taxable at the ordinary income rate, because the entire profit will come