Bonus Depreciation

What is Bonus Depreciation?

Bonus depreciation allows firms to deduct a larger portion of their capital expenses in the first year. Allowing businesses to write off certain purchases more quickly (specifically, bonus depreciation applies to “short-lived” investments) reduces the cost of capital and encourages more investment.

How Does Bonus Depreciation Differ from Other Types of Depreciation?

Under current law, bonus depreciation allows businesses to deduct 100 percent of the total cost of their eligible investments in the first year. By contrast, depreciation deductions under MACRS only allow businesses to deduct a portion of the investment each year. For example, straight-line depreciation requires an investment to be expensed at a uniform amount at fixed intervals (e.g., every year) until the value of the asset reaches zero (see Table 1 below).

Table 1: Straight-Line versus Bonus Depreciation for a $1 million investment with a 5-year cost recovery period
Years 2020 2021 2022 2023 2024

Straight-Line Depreciation

Depreciation deductions

-$200,000

-$200,000

-$200,000

-$200,000

-$200,000

Remaining depreciable basis

$800,000

$600,000

$400,000

$200,000

$0

100% Bonus Depreciation

Depreciation deductions

$1 million

$0

$0

$0

$0

Remaining depreciable basis

$0

$0

$0

$0

$0

Source: Author’s calculation (2020). Note: For simplicity, this example does not use the declining balance method or conventions.

For example, if an agriculture company wanted to invest $1 million in new equipment to assist in farming, 100 percent bonus depreciation would allow the firm to exclude the entirety of the investment from its taxable income in the first year. Conversely, straight-line depreciation would only allow the company to deduct a fixed percentage (e.g., 20 percent) of its original investment each year until the value reached $0. In present-value terms (which reflects the idea that a dollar in the future is worth less than a dollar today), straight-line depreciation does not allow the company to ever fully deduct the value of initial investment (see table 2).

In this example, despite spending $1 million on equipment, the requirement to take deductions over five years instead of immediately reduces the present value of the deductions to the company to $887,543. Disallowing a portion of cost recovery understates costs, overstates profits, and increases the company’s tax burden.

Table 2. Present Value of Deductions for a $1 Million Investment
Type of Depreciation Present Value of Deductions

100% Bonus Depreciation

$1 million

Straight Line Depreciation (5-Year Asset)

$887,543

Source: Author’s calculation (2020). Assumes half-year convention and 5 percent discount rate.

What Are the Effects of Bonus Depreciation?

Bonus depreciation alleviates this problem since companies can deduct the full cost of their investment from taxable income. This lowers the cost of capital, which induces more investment and higher productivity, which in turn leads to increased jobs, higher wages, and economic growth.

Recent Updates to Bonus Depreciation

The Tax Cuts and Jobs Act (TCJA) of 2017 made significant progress in improving the cost recovery treatment of business investment by enacting 100 percent bonus depreciation, allowing the immediate write-off of certain short-lived investments. However, these provisions will only be in effect for five years before phasing out.

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