What Is Cost Segregation Bonus Depreciation?

If you’re a commercial or investment property owner, you’re probably aware that depreciation can be used to lower federal income tax liabilities. You can accelerate these tax benefits in the first year with bonus depreciation, but what is bonus depreciation, and how does it work?

In this post, we’ll take a look at bonus depreciation, including what property qualifies, how to claim it, and how cost segregation and bonus depreciation work together to maximize your tax benefits.

What Is Bonus Depreciation?

Bonus depreciation is a tax incentive that allows businesses to write off a large percentage of the cost of an asset in the first year it’s placed into service. In 2024, 60% of the cost of qualified property can be written off in the first year it’s placed in service.

It’s important to remember that bonus depreciation can only be claimed after the property is placed in service. If you purchase equipment in 2024 but it isn’t used in the business by the end of 2024, bonus depreciation can’t be claimed until 2025.

Bonus Depreciation Rates By Year

Upon its introduction through the Job Creation and Worker Assistance Act of 2002, bonus depreciation was set at 30%. The Jobs and Growth Tax Relief Reconciliation Act of 2003 increased bonus depreciation to 50%.

However, the Tax Cuts and Jobs Act of 2017 (TCJA) increased bonus depreciation to 100% for qualified property put into service after September 28, 2017. Unfortunately, starting after 2022, bonus depreciation is being reduced until it is phased out entirely in 2027.

Unless new legislation is passed, here are the rates of bonus depreciation by year:

What Is Qualified Property For Bonus Depreciation?

Property that qualifies for bonus depreciation includes:

• Modified Accelerated Cost Recovery System (MACRS) property with a depreciation period of 20 years or less (includes machinery, equipment, furniture, computers, etc.)
• Certain qualified leasehold improvement property placed into service after 2017
• 25-year water utility property
• Computer software that wasn’t obtained through the acquisition of a business or trade
• Vehicles with a useful life of 20 years or less
• Film, TV, and live theatrical productions placed in service after September 27, 2017

Prior to the TCJA, only new property that met the requirements qualified for bonus depreciation. However, used assets may also qualify if they meet the following conditions:

• The asset was not used by the taxpayer or predecessor before its acquisition
• The asset was not acquired from a related party or a component member of a controlled group
• The taxpayer’s basis in the asset is not determined by the seller’s or transferor’s adjusted basis in the property
• The taxpayer’s basis in the asset is not based on property acquired from a decedent
• The cost of the property does not include the basis of property determined by the reference to the basis of other property held by the taxpayer

To briefly sum it up, used property does not qualify if you used it before acquiring it (such as through a lease), it was acquired from a related property, or it was acquired through a tax-free transaction. If you’re unsure whether your used property qualifies for bonus depreciation, consult a tax preparer or accountant to avoid making a costly mistake on your tax return.

Cost Segregation & Bonus Depreciation

Cost segregation is a tax strategy used to accelerate depreciation on certain assets in commercial and investment properties. Through a cost segregation study, certain qualified assets and property improvements are identified and depreciated on an accelerated schedule of five, seven, or 15 years.

Following a cost segregation study, property owners can more easily identify assets that qualify for bonus depreciation and maximize tax benefits. While it’s possible to do your own cost segregation study, we recommend hiring one of the best cost segregation companies to complete this complex study.

How To Claim Bonus Depreciation

Under IRS rules, you are required to claim bonus depreciation on qualified assets. This depreciation can be claimed by completing IRS Form 4562, Depreciation and Amortization. This form should be completed and filed with your federal tax return for the year in which the asset or assets were placed in service.

If you don’t want to claim bonus depreciation, you can also use this form to opt out of bonus depreciation. A statement must also be provided with the form. Per IRS rules, taking this election applies to all qualified property within the same property class during the same taxable year. For example, if you opt out of bonus depreciation for a five-year asset placed in service in 2023, you’re opting out of bonus depreciation for all five-year property put in service in 2023.

The Bottom Line On Bonus Depreciation

If you own commercial or investment property, bonus depreciation can significantly boost your tax write-offs in the first year. However, understanding what property qualifies, classifying assets, and submitting the proper form to the IRS can be confusing — and inaccuracies can be costly.

To maximize your tax benefits, we strongly recommend working with an accountant or tax expert. These professionals can help you understand bonus depreciation as well as identify other strategies specific to your unique tax situation. We also recommend working with a cost segregation company that can help identify qualified assets and help you get the most out of everything from bonus depreciation to rental property depreciation.