Bonus Depreciation

Bonus depreciation is a federal tax provision under Section 168(k) of the Internal Revenue Code that lets a business deduct a large percentage of the cost of qualifying assets in the first year they are placed in service, rather than spreading the deduction across the asset's recovery period. It accelerates deductions and defers tax.

How Bonus Depreciation Works

Bonus depreciation works by allowing a business to expense the full eligible cost of short-life assets immediately instead of depreciating them over 5, 7, or 15 years. In commercial real estate the deduction pairs with a cost segregation study, which reclassifies portions of a building's basis into these shorter recovery periods so the accelerated write-off can apply.

The Internal Revenue Code limits bonus depreciation to qualified property, defined as tangible depreciable business assets with a recovery period of 20 years or less, including machinery, equipment, certain vehicles, and qualifying land improvements. A standard commercial building is depreciated over 39 years and does not qualify on its own. The value is unlocked only when a cost segregation study breaks the building into components that individually carry recovery periods of 20 years or less.

Under the One Big Beautiful Bill Act, signed July 4, 2025, the IRS confirmed in Notice 2026-11 (IR-2026-06, January 14, 2026) a permanent 100% first-year bonus depreciation deduction for qualified property acquired and placed in service after January 19, 2025. Taxpayers may instead elect a 40% or 60% rate for property placed in service in the first tax year ending after that date.

Why Bonus Depreciation Matters

Bonus depreciation matters because the time value of an early deduction can move a deal's after-tax return by hundreds of thousands of dollars. A deduction taken in year one is worth more than the same deduction spread across 39 years, since the tax it defers stays invested in the property rather than paid to the Treasury. The quotable rule: bonus depreciation does not erase tax, it moves the timing, and timing is money.

For an operator underwriting an acquisition, the deduction is a cash-flow lever, not an accounting footnote. A large first-year write-off can shelter rental income, reduce or eliminate current tax on the property, and in some cases produce a paper loss that offsets other income, subject to passive activity and real estate professional rules. That recovered cash can service debt, fund capital expenditures, or seed the next acquisition. Underwriting that ignores the deduction understates the true after-tax yield of a deal that qualifies.

Example

The value of bonus depreciation is clearest when you price the deduction against a marginal tax rate. Consider an investor who buys a commercial property, commissions a cost segregation study, and applies 100% bonus depreciation to the reclassified basis in year one.

The reclassified basis is 25% of the $8,000,000 depreciable building, or $2,000,000. Applying the 100% bonus rate to that $2,000,000 produces a $2,000,000 first-year deduction. At an assumed 37% marginal federal rate, the deduction shelters $2,000,000 of income and defers $2,000,000 times 0.37, or $740,000, of tax into future years. Without bonus depreciation, that same $2,000,000 would deduct over 5 to 15 years, and the year-one shelter would be a fraction of the amount. The 25% reclassification figure here is an illustrative input, not a fixed rule; actual studies vary by property type.

Variations and Edge Cases

Bonus depreciation has shifted repeatedly, and the applicable rate depends on when property was placed in service. Under the 2017 Tax Cuts and Jobs Act the rate was 100% through 2022, then phased down 20 points a year: 80% in 2023, 60% in 2024, and 40% for property placed in service before January 20, 2025. The 2025 law reset the rate to a permanent 100%.

Edge cases matter for underwriting. A cost segregation study is required to capture the deduction on real property, and recapture applies when the property is sold, so the deferred tax can come due at disposition. Passive activity rules can limit how much of the loss an investor uses in the current year. This entry is educational and is not tax advice; confirm treatment with a qualified tax adviser.

Bonus Depreciation vs Section 179

Bonus depreciation is often confused with Section 179 expensing, since both allow immediate first-year write-offs. Bonus depreciation applies automatically to all qualifying property in a class, has no annual dollar cap, and can create or increase a net loss. Section 179 is an election with a dollar limit and cannot push a business into a loss.

Both apply to property with a recovery period of 20 years or less. In practice, investors often apply Section 179 first, then bonus depreciation to the remaining basis. Section 179 limits per the OBBBA figures cited above.

Frequently Asked Questions

What is bonus depreciation in commercial real estate? Bonus depreciation is a Section 168(k) provision that lets an owner deduct a large percentage of the cost of qualifying short-life assets in the first year they are placed in service. In real estate it applies to building components reclassified by a cost segregation study into recovery periods of 20 years or less.

Is bonus depreciation 100% in 2025? For qualified property acquired and placed in service after January 19, 2025, bonus depreciation is a permanent 100% under the One Big Beautiful Bill Act, per IRS Notice 2026-11. Property placed in service earlier in 2025, before January 20, uses a 40% rate unless a different election applies.

What is the difference between bonus depreciation and Section 179? Bonus depreciation has no annual dollar cap and can create a loss, while Section 179 is capped at $2,500,000 for 2025 and cannot exceed taxable income. Bonus depreciation applies automatically to a class of property; Section 179 is elected asset by asset.

Related Terms

• Cost Segregation

• Capital Expenditures

• Net Operating Income

• Hard Costs

• Disposition