Bonus Depreciation 101

With all the political wrangling over bonus depreciation, here's a look at how it actually works.

Aircraft Depreciation

Aircraft Depreciation

We've all heard the term, but what is bonus depreciation and how does it work? Normally, when a business purchases a piece of durable capital equipment such as a printing press, a backhoe or a corporate jet, that business is allowed to deduct the cost of the equipment from its taxable income, thereby reducing its tax burden.

Keep in mind, however, that the business can’t deduct the full amount all at once. Instead, it has to divide up the purchase price and spread it out over several years (the number varies depending on the type of equipment purchased — for bizjets it’s currently set at five years, but the Obama Administration would like to stretch it to seven). The idea is that as the equipment wears out or becomes obsolete, its value to the business decreases, and the business is allowed to recognize this loss in value — the depreciation — as a deductible business expense.

“Bonus” depreciation allows the business to deduct from its taxable income a larger percentage of the purchase price in the year of purchase than would be allowed under the standard depreciation rules. For example, if a business could normally deduct 20 percent of the purchase price of an aircraft in Year One, under 50 percent bonus depreciation, that business would end up deducting, for tax purposes, 60 percent in Year One.

In real economic terms, while the company “consumed” only 20 percent of the value of the aircraft in Year One, it reported taxable income as if it had consumed 60 percent of the aircraft in that year. That 40 percent difference between actual and taxable income represents the bonus depreciation tax break. But you better hurry to take advantage. The White House wants to put an end to bonus depreciation for business aircraft purchases at the end of this year.