|
Depreciation Options |
|
Depreciation
Options for Late-year Asset Purchases Taxpayers have several options
for depreciating property acquired near the end of the year. They can (1)
recover the property's tax basis over the proper recovery period in the form
of depreciation deductions, (2) deduct up to $100,000 (for 2003) of the cost
of eligible property acquired during the year under IRC Sec. 179, and/or (3)
claim the Section 168(k) 50% (or 30%) bonus deprecation deduction for
qualified new property. The Section 179 and 168(k)
additional depreciation deductions are discussed in the following paragraphs. Applying the Half-year or Midquarter Convention Depreciable assets other than
real property are subject to a half-year convention for calculating tax
depreciation, while real property is subject to a midmonth convention. Regardless
of the actual acquisition date, property subject to the half-year convention
is assumed to have been placed in service at the tax year's midpoint. This
method also provides a business with half a year's depreciation deduction in
the year of disposition. The midquarter
convention must be used if more than 40% of the aggregate basis of property
(excluding most real property) is placed in service during the last three
months of the tax year [IRC Sec. 168(d)(3)]. If the midquarter
convention applies, all property acquired during the year is assumed to have
been placed in service at the midpoint of the quarter in which it is
acquired. Normally, taxpayers want to avoid
the midquarter convention since property acquired
after the midpoint of the tax year is entitled to less depreciation in the
first year than under the half-year convention. Calendar-year taxpayers can
purchase assets as late in the year as they want and still use the half-year
convention if at least 60% of the assets are placed in service on or before
September 30. Claiming the Section 179 Deduction The Jobs and Growth Tax Relief
Reconciliation Act of 2003 (the 2003 Act) increased the maximum dollar amount
that may be deducted under IRC Sec. 179 to $100,000 for property placed in
service in tax years beginning in 2003, 2004, and 2005. (After 2005, the
limit reverts back to $25,000.) For partnerships and S corporations, the
annual limit applies at both the entity and the owner level. In addition to the annual dollar
limit, the allowable Section 179 deduction is (1) limited to the amount of
taxable income for the year and (2) reduced dollar-for-dollar to the extent
eligible Section 179 property placed in service for the year exceeds a
threshold amount. In prior years, the threshold amount was $200,000. However,
the 2003 Act increased the threshold amount to $400,000 for 2003, 2004, and
2005. (After 2005, the limit reverts back to $200,000. Qualifying property includes
tangible property that is (1) subject to depreciation, amortization, or some
other reasonable allowance for wear and tear; (2) Section 1245 property, as
defined in IRC Sec. 1245(a)(3); (3) acquired by purchase from an unrelated
party; and (4) used more than 50% in an active business (i.e., not an
investment use). No Proration
of Section 179 Deduction. If Section 179 property is placed in service in a
short tax year (e.g., during a company's initial tax year) or near the end of
the tax year, no proration of the Section 179
deduction is required [Reg. 1.179-1(c)]. For example, assume that on Relationship with Midquarter Convention. The cost of property expensed
under IRC Sec. 179 is excluded when applying the 40% rule under the midquarter convention test. Because the business can
choose which assets it will expense under IRC Sec. 179, the deduction can be
used to avoid or trigger the midquarter convention. Assume that Smallcorp
is a calendar-year C corporation that renovates and resells used aluminum
baseball bats. In January 2003, it bought a $10,000 bat-polishing machine. In
December 2003, it bought a $15,000 grinding machine. On its 2003 return, Smallcorp elects to expense the $15,000 grinder and
$5,000 of the cost of the polisher under IRC Sec. 179. In applying the 40% test, Smallcorp is considered to have placed in service
property with a total depreciable basis of $5,000 in January 2003. The
$20,000 of property expensed under IRC Sec. 179 is not considered. Therefore,
the midquarter convention does not apply since 100%
of the total basis of the property was placed in service in the first quarter
of 2003. The $5,000 remaining basis in the polishing machine is depreciated
using the normal half-year convention. Claiming Bonus Depreciation 30% Bonus Depreciation. The Job
Creation and Worker Assistance Act of 2002 authorized an additional
first-year (bonus) depreciation deduction equal to 30% of the adjusted basis
of qualified property [IRC Sec. 168(k)]. For these purposes, qualified
property is (1) property with a recovery period of 20 years or less, (2)
water utility property, (3) computer software that is not covered by IRC Sec.
197, or (4) qualified leasehold improvement property. Furthermore, the original use of
the property must commence with the taxpayer after September 10, 2001, and
the property must be placed in service before January 1, 2005, although a
one-year extension of this date is available for certain property. Finally, the taxpayer must
purchase the property within the applicable time period, which generally is
after 50% Bonus Depreciation. The 2003
Act increased the bonus depreciation amount from 30% to 50% of the adjusted
basis of qualified property. Qualified property is defined in the same manner
as for purposes of 30% bonus depreciation, except the applicable time period
for acquisition (or self-construction) of the property is modified. To
qualify for the 50% bonus depreciation deduction, property generally must be
acquired and placed in service after The 2003 Act makes property
acquired as late as Other Rules. Qualified property
does not include property subject to the alternative depreciation system
(ADS) under IRC Sec. 168(g), other than where the taxpayer voluntarily elects
ADS. Bonus depreciation also cannot be claimed for listed property used 50%
or less for business purposes [IRC Sec. 280F(b)(1)]. Bonus depreciation is allowed for
regular tax and for AMT purposes [IRC Sec. 168(k)(2)(F)].
In addition, depreciation claimed for the remaining adjusted basis of the
property is also allowed for both purposes (Rev. Proc. 2002-33). Electing Out of Bonus
Depreciation. On a class-by-class basis (i.e., five-year property, seven-year
property, etc.), businesses can claim the 30% bonus depreciation, the 50%
bonus depreciation, or no bonus depreciation. An election out of the 50%
bonus depreciation is an election into the 30% bonus depreciation. Thus,
businesses that want to elect out of all bonus depreciation must elect out of
both the 50% and the 30% bonus depreciation allowances [IRC Sec. 168(k)(2)(C)(iii)]. An election to not deduct bonus
depreciation is made separately by each person owning qualified property
(i.e., by each member of a consolidated group, by the partnership, by the S
corporation, etc.) (Rev. Proc. 2002-33). To make the election, a business
must attach a statement to the return indicating the class of property for
which the election not to claim the additional depreciation is made. A business that chooses not to
claim the bonus depreciation must follow the procedures for electing out.
Otherwise, the depreciation is deemed allowed, regardless of whether the
taxpayer actually claimed the deduction on the return. A deemed allowance can
impact future allowable depreciation deductions as well as gain or loss when
the property is eventually sold. No Proration
of Bonus Depreciation. Bonus depreciation is determined without any proration based on when the property was placed in
service during the tax year. Therefore, as with the Section 179 deduction,
the 30% or 50% bonus depreciation is available even if the asset is purchased
on the last day of the year. Coordination with Section 179
Deduction. Bonus depreciation is claimed after any Section 179 deduction, but
before calculating the regular depreciation for the property. Assume that on Relationship with Midquarter Convention.
In measuring whether 40% of the aggregate basis of property is placed
in service during the last three months of the tax year so as to require use
of the midquarter convention, the basis of property
is first reduced by any Section 179 deduction [Reg. 1.168(d)-1(b)(4)]. Thus,
as previously noted, a common tax-planning strategy is to claim the Section
179 deduction for assets purchased during the last quarter to help the
taxpayer avoid the 40% threshold for the midquarter
convention. However, bonus depreciation is a
Section 168 depreciation deduction. Furthermore, the midquarter
40% test applies to the aggregate basis of property to which IRC Sec. 168
applies [IRC Sec. 168(d)(3)(A)(ii)]. The upshot is
that new business assets purchased in the last quarter of the year are
eligible for the entire 50% (or 30%) bonus depreciation, but the full cost of
those assets is used in determining whether a taxpayer is subject to the midquarter convention when computing regular
depreciation. Concluding Thought Taxpayers generally will want to
write off the cost of property as quickly as possible. However, in some
situations, taxpayers can benefit from not claiming the additional
depreciation allowances. For example, taxpayers with expiring NOL carryovers
and those with a low marginal tax rate now but who expect to be in a higher
marginal tax rate in the future may be better off pushing as much of the
depreciation deduction as possible to future tax years. |
|
|
|||
|
|
|||
|
|
Copyright © 2005 Regalia & Associates |
Last Modified |
|
