Bonus depreciation is a special method of depreciation that most businesses use to reduce their taxable income by allowing a deduction for expenses that are used up in the year. Bonus depreciation can apply to business property, such as equipment and furnishings, or can apply to business casualty, which includes depreciated operating lease property or depreciated tools and machinery. This type of depreciation also covers assets used principally for trade, such as office furniture and appliances, and certain computer and cable equipment. These types of assets are considered a business liability because they depreciate faster than assets that are used principally for business. In most cases, the allowable amount of bonus depreciation is equal to the balance of the accruals (means of operation plus expenses) less the net worth of the assets, divided by the period of ownership, determined on the date of purchase or acquisition.
Depreciation is normally allocated on a first in first out (FIFO) basis; however, in the case of bonus depreciation, it is applied in accordance with the ratio of the total regular depreciation expense incurred to the total regular depreciation expense incurred discount and bonuses. The second in first out method of depreciation is used in situations where the asset was acquired for investment-grade status and is used primarily for revenue-generating purposes. It does not matter whether the qualifying property is placed in a commercial or residential zone, if it qualifies as an investment property the allowable percentage is 100%.
Business owners can take advantage of the bonus depreciation by reducing the taxable income of the business. In the case of businesses that consist of residential rental properties, in which the property is let out to qualified tenants, this can be done by increasing the tenant pay rate on a monthly basis, thereby allowing the property to depreciate more quickly. Certain types of commercial businesses are placed in separate accounts receivable and payables; in such circumstances, the business can reduce its taxable income by allowing a larger number of monthly payments to be paid to the account. Other businesses, which have assets that are used principally for the operation of the business and which qualify for the bonus depreciation provision, include certain types of professional services, such as doctors’ offices, dentists’ offices, lawyers’ offices, etc., and certain types of contractors.