What Is Bonus Depreciation?

Bonus depreciation is an accelerated first-year deduction under Internal Revenue Code section 168(k) that allows a business to deduct a percentage of the cost of qualified property in the year it is placed in service. The percentage has stepped down from 100% for property acquired and placed in service after September 27, 2017 and before January 1, 2023, to 80% for 2023, 60% for 2024, 40% for 2025, and 20% for 2026, with full expiration after 2026 unless Congress acts. It applies to both new and used property, provided the taxpayer had not used the property before and did not acquire it from a related party.

How the Mechanics Work in Practice

The deduction is taken after the regular depreciation basis is reduced, but before regular MACRS depreciation on the remaining basis. A firm buys a $2 million piece of manufacturing equipment and places it in service in 2024. The bonus depreciation rate is 60%. The firm takes $1.2 million in bonus depreciation immediately. The remaining $800,000 basis is then depreciated under the normal 7-year MACRS schedule.

Property Qualification Rules

Qualified property includes MACRS property with a recovery period of 20 years or less, computer software, water utility property, and qualified improvement property. The property must be placed in service during the tax year for which the bonus is claimed. Used property qualifies if it was not previously used by the taxpayer and was not acquired from a related party under section 267 or 707.

The placed-in-service date controls, not the acquisition date. A firm that signed a purchase contract in December 2022 but did not install the equipment until March 2023 took 80% bonus, not 100%. The installation date, not the invoice date, is what the IRS examines.

Election Out

A taxpayer can elect out of bonus depreciation for any class of property on a timely filed return. The election is made on Form 4562, Depreciation and Amortization, and is irrevocable. Firms with net operating losses or passive activity limitations sometimes elect out to preserve depreciation deductions for future years when they expect taxable income. A cost segregation study firm advising a client with $5 million in improvements should model both scenarios before the return is filed.

Why Bonus Depreciation Matters to Cost Segregation and Tax Credit Firms

For a cost segregation study firm, bonus depreciation is the lever that turns a 39-year straight-line building into front-loaded deductions. A $10 million commercial building might have $3 million in 5-year and 7-year personal property identified through cost segregation. At 60% bonus depreciation in 2024, that yields $1.8 million in immediate deductions plus regular MACRS on the remaining $1.2 million. Without cost segregation, the entire $10 million stays in 39-year real property with no bonus eligibility.

The interaction with section 179 expensing creates planning complexity. Section 179 allows up to $1.22 million of expensing for 2024, subject to phase-out starting at $3.05 million of qualified property purchases. Bonus depreciation has no dollar cap. A firm with $10 million in equipment purchases will exhaust section 179 and still have $8.78 million eligible for bonus depreciation.

The 2026 Cliff and Client Conversations

Your clients are business owners who may not track legislative sunsets. A manufacturer who deferred capital investment planning until 2025 based on 2023 conversations about 100% bonus depreciation is now facing 40% and needs to understand the changed math. The 20% rate for 2026 and zero thereafter, absent extension, means the after-tax cost of a $2 million equipment purchase rises substantially. A cost segregation study firm that can model this precisely, showing the actual NPV of deductions at each rate, distinguishes itself from competitors who quote generic savings figures.

Where Practitioners Misapply Bonus Depreciation

The Related Party Trap

A common and costly error occurs when a taxpayer acquires property from a related party and assumes bonus depreciation applies. IRC section 168(k)(2)(E) explicitly excludes related-party transactions. A real estate developer who buys equipment from a partnership in which he holds a 50% interest gets no bonus depreciation. The property still qualifies for regular MACRS, but the expected first-year deduction vanishes. Firms should verify ownership chains before filing returns, not after an IRS examination.

QIP and the Technical Correction

Qualified improvement property was intended to qualify for bonus depreciation from the 2017 Tax Cuts and Jobs Act, but a drafting error left it with a 39-year recovery period and thus ineligible. The CARES Act of March 2020 corrected this retroactively to January 1, 2018. Firms with QIP placed in service in 2018, 2019, or early 2020 may have missed the opportunity and can still file amended returns. The amendment window is closing. A cost segregation study firm that does not proactively review client files from those years for QIP eligibility is leaving money on the table.

State Conformity Gaps

Bonus depreciation is a federal provision. States conform to the IRC on varying schedules, and many decouple from section 168(k). California allows no bonus depreciation. Texas conforms to the IRC as of January 1, 2007, and thus does not recognize bonus depreciation. A firm that models federal tax savings without state-by-state adjustment delivers incomplete advice. The client who deducts $1.2 million federally and adds it back entirely for state purposes has a different effective rate than the federal model suggests.

Related Terms in Tax Credit Capture

A practitioner in this vertical should also understand Section 179 Expensing, which operates as an alternative first-year deduction with its own dollar limits and phase-outs; Cost Segregation Study, the methodology that identifies shorter-recovery property within a building to maximize bonus eligibility; R&D Tax Credit (Section 41), which can be paired with bonus depreciation for qualified research equipment; and Qualified Research Expense (QRE), which defines the in-house and contract research costs that may fund both the credit and the depreciable basis.