As we all know by now, most tax structures are set to expire the end of this year. The two most popular provisions for small businesses (bonus depreciation and §179 expensing) are set to expire. At this time it is uncertain as to how these provisions will look next year, so it is important to take advantage of these provisions in 2012 where applicable.
Unless Congress acts, additional bonus depreciation deductions (50% of new assets) won’t be available after this year and §179 expensing limit is set to plummet to $25,000 for property placed in service next year.
Businesses planning to purchase machinery and equipment during the remainder of this year or early the next should try to accelerate their buying plans, if doing so makes sound business sense.
Here are some planning ideas for businesses looking to purchase assets before the end of the year:
Buy Depreciable Property and Place It in Service This Year to Lock in 50% Bonus First-Year Depreciation
Under current law, a 50% bonus first-year depreciation allowance applies to qualified property acquired and placed in service after Dec. 31, 2011 and before Jan. 1, 2013. The adjusted basis of qualified property is reduced by the additional 50% depreciation deduction before computing the amount otherwise allowable as a depreciation deduction for the tax year and any later tax year.
If §179 expensing is claimed on qualified property, the amount expensed “comes off the top” before the additional 50% first-year depreciation allowance is computed.
Then the taxpayer computes regular first-year depreciation (and depreciation for future years) with reference to the adjusted basis remaining after expensing and after the additional 50% first-year allowance. There is no alternative minimum tax (AMT) depreciation adjustment for property written off under this provision.
Example: ABC, Inc., a calendar-year business, needs to buy $500,000 of equipment (assume five-year property for tax purposes). If it does so before Jan. 1, 2013, and places the property in service before that date, ABC may claim a first-year depreciation allowance of $300,000 [($500,000 × .50 = $250,000 bonus depreciation) + ($500,000 − $250,000 × .20 =$50,000 regular first-year depreciation)]. If it waits until 2013 to buy the assets, and bonus first-year depreciation isn’t extended, ABC’s regular first-year depreciation allowance using the half-year convention would be only $100,000 (20%).
The bonus depreciation deduction is determined without any proration based on the length of the tax year. As a result, accelerated first-year deductions are available even if qualifying assets are in service for only a few days in 2012.
Accelerating a purchase into 2012 may not always be a good idea. For example, it may not produce good results for a taxpayer that has an about-to-expire net operating loss. On the other hand, if accelerating the purchase will produce a net operating loss for 2012 that can be carried back to 2010, and the taxpayer had income taxed at the highest rate in that year, then this may be a good reason to make the purchase in 2012.
How to qualify for bonus depreciation.
In general, an asset purchased in 2012 qualifies for the bonus depreciation allowance if:
- It falls into one of the following categories: property to which the modified accelerated cost recovery system (MACRS) rules apply with a recovery period of 20 years or less; computer software other than computer software covered by the amortization of goodwill and other intangibles rules of Code Sec. 197; qualified leasehold improvement property (i.e., certain interior improvements to nonresidential buildings); or certain water utility property.
- It is placed in service before Jan. 1, 2013 (certain aircraft and certain property with a long production period may be placed in service before Jan. 1, 2014).
- Its original use commences with the taxpayer. Original use is the first use to which the property is put, whether or not that use corresponds to the taxpayer’s use of the property.
The 50% additional first-year depreciation allowance applies to qualified property unless the taxpayer “elects out.” The election out may be made for any class of property for any tax year, and if made applies to all property in that class placed in service during that tax year.
A taxpayer that “elects out” of additional first-year depreciation for a specific class of property is subject to the AMT depreciation adjustment for property in that class. That means AMT depreciation is computed using the 150% declining balance method (switching to straight line in the year necessary to maximize the allowance), except that straight line is used for property for which straight-line depreciation must be used for regular tax purposes. The recovery period is the same for AMT and regular tax purposes.
For “eligible qualified property” (generally, qualified property eligible for bonus depreciation) that is originally used and acquired after Dec. 31, 2010 and placed in service before Jan. 1, 2013 (Jan. 1, 2014 for certain long-production period property and certain aircraft), corporations can elect to forego bonus depreciation and accelerated depreciation in exchange for an increased AMT credit limitation.
Last year for extra-generous luxury auto depreciation limits?
If bonus first-year depreciation deductions come to an end at the close of 2012, so will the extra-generous first-year dollar limit on autos, light trucks, and vans, so called “luxury auto” rules. The first-year depreciation deduction for new vehicles that qualify for bonus depreciation is $8,000 more than the first-year depreciation limit that would otherwise apply.
For new vehicles bought and placed in service in 2012, and that qualify for bonus first-year depreciation, the boosted first-year dollar limit is $11,160 for autos (not trucks or vans), and $11,360 for light trucks or vans (passenger autos built on a truck chassis, including minivans and sport-utility vehicles (SUVs) built on a truck chassis). The regular first-year luxury auto limits (e.g., for vehicles not eligible for bonus depreciation, or for which the taxpayer elects out of bonus depreciation) are $3,160 for autos and $3,360 for light trucks or vans. However, under current law, these boosted dollar amounts apply only for vehicles bought and placed in service before 2013. As a result, taxpayers thinking of buying a new auto, light truck or van for trade or business use should buy the vehicle and place it in service this year if they want to maximize first-year deductions.
Heavy SUVs—those that are built on a truck chassis and are rated at more than 6,000 pounds gross (loaded) vehicle weight—are exempt from the luxury-auto dollar caps because they fall outside of the definition of a passenger auto. Under the law, not more than $25,000 of the cost of a heavy SUV may be expensed under Code Sec. 179. The balance of the heavy SUV’s cost may be depreciated under the regular rules that apply to five-year property. However, with the 50% first-year bonus depreciation available for qualified assets bought and placed in service in 2012 (in addition to the $25,000 expensing allowance and regular depreciation), taxpayers buying and placing in service new heavy SUVs in 2012 may be entitled to write off most of the cost of the vehicle in the first year.
If you are planning on buying equipment or vehicles for your business, special care needs to be taken to maximize the benefit of these tax provisions. If you have any questions regarding bonus depreciation or your specific circumstances, please do not hesitate to contact us.