Wednesday, September 9, 2009

Federal Tax Alert: Tax Advantages of Accelerating Purchases of Depreciable Assets Into 2009

This is the first of a series of blogs that discusses the tax advantages that may be realized by accelerating planned depreciable asset purchases into the 2009 calendar year to take advantage of bonus depreciation.

Buy Depreciable Property and Place it in Service This Year to Lock In Bonus First-Year Depreciation

Unless Congress acts, bonus depreciation deductions under IRC § 168(k) in the placed-in-service year equal to 50% of the adjusted basis of qualified property won't be available for most depreciable asset purchases made after 2009. Thus, enterprises planning to purchase new depreciable property in the 2009 calendar year or the 2010 calendar year should try to accelerate their purchases into the 2009 calendar year, if: (a) doing so makes sound business sense and (b) the tax advantage from increasing depreciation expense in 2009 is greater than the tax disadvantage of reducing the depreciation claimed in future tax years.

Caution: The highest individual income tax rate is scheduled to increase from 35% in 2009 to 39.6% in 2011. The higher tax rate decreases the tax advantage of accelerating purchases into 2009 because post-2010 deductions will reduce tax by a greater amount than will pre-2011 deductions.

Here's how the rules work:

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 IRC § 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 AMT depreciation adjustment for property written off under IRC § 168(k).

Example: ABC, Inc, a calendar-year business, needs to buy $500,000 of five-year MACRS property. If it does so before Jan. 1, 2010, 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) + ($500,000 − $250,000 × .20 = $50,000)]. If it waits until 2010 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.

How to qualify for bonus depreciation. In general, an asset purchased in 2009 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 IRC § 197; qualified leasehold improvement property; or certain water utility property;

  • it is placed in service before Jan. 1, 2010. (Certain property with a recovery period of 10 or more years and certain transportation property may qualify if it is placed in service before Jan. 1, 2011); and

  • its original use commences with the taxpayer.

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.

Caution: A taxpayer that “elects out” of additional first-year depreciation for a specific class of property is subject to the AMT depreciation adjustment for that "opt-out class."

Last Year for Extra-Generous Luxury Auto Depreciation Limits?

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 2009, and that qualify for bonus first-year depreciation, the boosted first-year dollar limit is $10,960 for autos (not trucks or vans), and $11,060 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 used vehicles) are $2,960 for autos and $3,060 for light trucks or vans. The above boosted dollar amounts apply only for vehicles bought and placed in service before 2010. 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.

Observation: 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 IRC § 179(b)(6), not more than $25,000 of the cost of a heavy SUV may be expensed under IRC § 179. The balance of the heavy SUV's cost may be depreciated under the regular rules that apply to 5-year MACRS property (e.g., a 20% first-year depreciation allowance if the half-year convention applies for the placed in service year). However, with the 50% first year bonus depreciation available for qualified assets bought and placed in service in 2009 (in addition to the $25,000 expensing allowance and regular depreciation), taxpayers buying and placing in service new heavy SUVs in 2009 may be entitled to write off most of the cost of the vehicle.