Resource Guide
Best Practices in Fixed Assets Management A Resource Guide for Claiming Bonus Depreciation Nancy Faussett, CPA
Table of Contents Introduction
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Background
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Property Qualifying for Bonus Depreciation General Bonus Depreciation Property Longer-Production-Period Property and Certain Aircraft Additional Property Types Qualifying for Bonus Depreciation
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50% Expensing versus Bonus Depreciation
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Calculation of Basis for Bonus Depreciation
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AMT Depreciation Adjustment
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Election Not to Claim Bonus Depreciation
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Election to Claim 50% Bonus Depreciation Instead of 100% Bonus
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Retroactive Application of 50% Bonus Depreciation
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Accounting Method Changes for Claiming Bonus Depreciation
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Luxury Vehicles and Bonus Depreciation
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Long-Term Contracts and Bonus Depreciation
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Short Tax Years
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Mid-Quarter Convention
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States and Bonus Depreciation
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Electing Out of Bonus Depreciation for Refundable Credits
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Bonus Depreciation vs. Section 179 Expense Similarities Differences
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Considerations for Claiming Bonus Depreciation
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BNA Fixed Assets™ Solutions
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BNA Software
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About BNA
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About Nancy Faussett
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Best Practices in Fixed Assets Management A Resource Guide for Claiming Bonus Depreciation
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Introduction There is an additional depreciation deduction allowed on qualifying property in the year it is placed in service. Generally, the deduction is 50% (although, depending on its placed-in-service date, it may be 100%) of the asset’s unadjusted depreciable basis and it reduces the asset’s basis on which other depreciation may then be claimed. This additional deduction is termed “additional first-year depreciation” or “bonus depreciation.” The rules governing bonus depreciation can be found in IRS Code Section 168(k).This Resource Guide will answer all of your questions about this deduction: ●● ●● ●● ●● ●● ●● ●● ●●
What property qualifies for either the 50% or the 100% deduction? What basis do I use to calculate the deduction? How does the new deduction affect the AMT depreciation adjustment? Is the deduction mandatory? Can I choose which assets I want to claim it on? Does a short tax year affect its calculation? How is the 40% test for the mid-quarter convention affected by it? Is it applied any differently to listed property?
Background When you look at the rules for bonus depreciation, you will see that what started out as a simple boost to depreciation has become more and more complex as to which property qualifies for the deduction. There is no doubt as to its popularity as an economic incentive for businesses. When originally created (by the Job Creation and Worker Assistance Act of 2002), additional First-Year depreciation, a.k.a. “bonus depreciation,” was only for 30% of the asset’s depreciable basis and it was supposed to be temporary. To qualify for the 30% bonus depreciation, qualifying property had to be acquired after September 10, 2001 and placed in service before January 1, 2005 (although you had an additional year to claim it on certain property). Bonus depreciation was brought back by the Economic Stimulus Act of 2008. It is important to note that it was not extended by the 2008 Act but rather the provision for bonus depreciation was allowed to expire and then it was reintroduced. It was not made retroactive. Since then it has been extended three times: first by the American Recovery and Reinvestment Act of 2009, then by the Small Business Jobs Act of 2010, and, most recently, by the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010. This means that bonus depreciation is now available for qualifying assets placed in service through 2012 (with certain aircraft and property having a longer production period through 2013). One of the most important changes is that the 2010 Act temporarily increases, to 100%, the bonus depreciation deduction for qualifying property placed in service after September 8, 2010, through 2011 (through 2012 for certain aircraft and long-production-period property).
Note: Although 100% expensing is only for about 16 months, since the extension of bonus depreciation is for two years, 50% bonus depreciation will still be allowed during 2012 (and during 2013 for certain aircraft and long-production-period property).
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Due to its popularity, more and more legislation has been passed in the last several years to allow the use of bonus depreciation in specific areas of the country that Congress felt needed further economic assistance. It has been used to aid hurricane victims and to assist businesses located in federally declared disaster areas. Furthermore, there is also a special 50% expensing, which is quite similar to bonus depreciation, for very specific types of property.
Property Qualifying for Bonus Depreciation General Bonus Depreciation Property To claim the bonus depreciation deduction, qualifying property must be new property that is acquired and placed in service after December 31, 2007, and before January 1, 2013 (although certain property can be placed in service up until January 1, 2014, see the following section). In addition, such property must be included in one of the following categories: ●● MACRS property with a recovery period of 20 years or less, ●● Computer software that is not Section 197 property (that is, software that is defined in Section 167(f) (1)(B)), ●● Water utility property, or ●● Qualified leasehold improvement property (generally, this includes most leasehold improvements made to nonresidential real property that are placed in service more than three years after the building was initially placed in service).
Note: Revenue Procedure 2011-26 clarifies that qualifying restaurant property (Section 168(e) (7)) and retail improvement property (Section 168(e)(8)) are eligible for either the 50% or the 100% bonus depreciation deduction, based on their placed-in-service date.
To claim the temporary 100% bonus depreciation deduction under Section 168(k)(5), qualifying property must meet all of the above qualifications except that it must be acquired and placed in service after September 8, 2010, and before January 1, 2012 (or before January 1, 2013 for certain aircraft and longproduction-period property). However, it may be possible to elect to claim 50% bonus depreciation for such property instead of the 100% bonus depreciation deduction. (See the section entitled “Election to Claim 50% Bonus Depreciation Instead of 100% Bonus” in this Guide.) Furthermore, there are special rules covering specific scenarios. For property to qualify for the current bonus depreciation deduction: ●● If the property is acquired under a written, binding contract for its acquisition, such contract must be entered into after December 31, 2007 and before January 1, 2013. ●● If the property is manufactured, constructed, or produced by the taxpayer and for use by the taxpayer, the taxpayer must begin such activity on the property after December 31, 2007, and before January 1, 2013 (or, for 100% bonus depreciation, after September 8, 2010 and before January 1, 2012). ●● There is a limited exception for components acquired or self-constructed and qualifying for 100% bonus depreciation: If the taxpayer begins the manufacture, construction, or production of larger Best Practices in Fixed Assets Management A Resource Guide for Claiming Bonus Depreciation
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self-constructed property before September 9, 2010, the taxpayer may elect to treat any component of the property as being eligible for the 100% bonus deduction if the property qualifies and is acquired or self-constructed after September 8, 2010 and before January 1, 2012 (or before 2013 for certain aircraft and long-production-period property). The election must be made by the due date of the return (including extensions) and by attaching a statement to the return indicating it is being made under “Section 3.02(2)(b) of Rev. Proc. 2011-26.” Such statement should indicate the components for which the election is being made. Furthermore, if the taxpayer timely filed its return on or before April 18, 2011, for the tax year in which the larger self-constructed property is placed in service, there is an automatic 6-month extension from the due date of that return (excluding extensions) to make this election pursuant to IRS Reg. 301.9100-2 (b). There is certain property that does not qualify for bonus depreciation: ●● Property that is required to use the MACRS Alternative Depreciation System (ADS) under Section 168(g). This includes, for example, property used predominantly outside of the United States and certain imported property. It also includes listed property that is not used more than 50% of the time for qualified business use (Section 280F(b)(1)). ●● Property that is described under Section 168(f), such as films and videotapes.
Note: If you elect to use MACRS ADS for any other property, this does not make such property ineligible for bonus depreciation. ●● Property included in any asset class for which an election was made not to claim bonus depreciation (see page 7 for a discussion of this election).
Longer-Production-Period Property and Certain Aircraft Bonus depreciation is also allowed for certain property placed in service in 2008 through 2013 (with one exception*). Qualifying property is property having longer production periods and certain aircraft.
*Exception: Qualifying longer-production-period property and certain aircraft can only claim the temporary 100% bonus depreciation deduction if placed in service before January 1, 2013. Property having longer production periods must meet the same qualifications of all other property qualifying for bonus depreciation as described on the previous page, be placed in service before January 1, 2014, and: 1. Have a recovery period of at least 10 years or be transportation property, 2. Be subject to the Uniform Capitalization rules of Section 263A, and 3. Meet the requirements of Section 263A(f)(1)(B)(iii), meaning that it has a production period exceeding one year and costs more than $1 million. Property having a longer production period can qualify for the December 31, 2013 placed-in-service deadline only to the extent of its adjusted basis attributable to manufacture, construction, or production after December 31, 2007 and before January 1, 2013.
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Qualifying aircraft must also meet the same requirements of all other property qualifying for bonus depreciation, be placed in service before January 1, 2014, and: 1. Not qualify as “transportation property” (that is, it cannot be tangible personal property used in the trade or business of transporting persons or property) other than for agricultural or firefighting purposes, 2. Be purchased and such purchase must require a nonrefundable deposit of the lesser of 10% of the cost or $100,000, and 3. Have an estimated production period exceeding four months and a cost exceeding $200,000.
Additional Property Types Qualifying for Bonus Depreciation Businesses may also claim bonus depreciation on the following types of property: ●● New York Liberty Zone property: 30% bonus depreciation, under IRS Code Section 1400L(b), was allowed on nonresidential real property and residential rental property that is qualified Liberty Zone property. Such property must have been new property acquired after September 10, 2001 and placed in service before January 1, 2010. If a binding contract to acquire the property existed before September 11, 2001, the property did not qualify. Also, to qualify, substantially (80% or more) of the property’s use must be in the Liberty Zone. ●● Gulf Opportunity Zone property: Qualified Gulf Opportunity Zone property (a.k.a. “GO Zone property”), under IRS Code Section 1400N(d), was allowed 50% bonus depreciation if acquired after August 27, 2005 and placed in service before 2008 (before 2009, in the case of nonresidential real property and residential rental property). This provision was created to assist victims of Hurricanes Katrina, Wilma, and Rita. In addition, “specified GO Zone extension property” qualifies for 50% bonus depreciation if it is placed in service before 2012. Such property, for the most part, is qualifying property that is general bonus depreciation property* or it may be nonresidential real property or residential rental property. Qualifying property must be placed in service in specific areas of the GO Zone, defined in IRS Section 1400N(d)(6)(C). Furthermore, if a binding contract to acquire the property existed before August 28, 2005, it will not qualify. *One difference is that substantially all of the use of GO Zone property must be within a qualifying building and be placed in service no later than 90 days after the building is placed in service.
Furthermore, if the GO Zone property is self-constructed property, the taxpayer must have begun its manufacture, construction, or production after August 27, 2005. If the GO Zone property is a sale-leaseback, the property that was originally placed in service by a person after August 27, 2005, and sold and leased back by that person within three months after the date it is originally placed in service, is treated as originally placed in service not earlier than the date on which the property is used under the leaseback (see IRS Code Section 1400N(d)(3)).
50% Expensing versus Bonus Depreciation There is a 50% special depreciation allowance, similar to bonus depreciation, allowed on certain types of property. Generally, the same rules as for bonus depreciation apply. For example, the depreciable basis of the asset is reduced by the amount of bonus depreciation claimed. The following types of property may claim this deduction:
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●● Qualified cellulosic biomass ethanol plant property placed in service after December 20, 2006 and before January 1, 2013. The property must be used only in the U.S. to produce cellulosic biomass ethanol. ●● Qualified cellulosic biofuel plant property placed in service after October 3, 2008 and before January 1, 2013. The property must be used only in the U.S. to produce cellulosic biofuels. ●● Qualified reuse and recycling property placed in service after August 31, 2008. Qualifying property must be new, have a useful life of at least 5 years, and is any machinery and equipment (including the software needed to operate it) that is used “exclusively to collect, distribute, or recycle qualified reuse and recyclable materials.” This does not include property on which bonus depreciation can be claimed. Qualified reuse and recycling property is defined in IRS Code Section 168(m). ●● Qualified Disaster property: The Emergency Economic Stabilization Act of 2008 provided relief for newly acquired business property located in a federally declared disaster area in which the disaster occurred after 2007 and before 2010, under IRS Code Section 168(n). Initially, this was intended for a 10-state region known as the Midwestern Disaster Area, but as part of the Act, Congress wanted to extend the relief to future storm victims where there is a federally declared disaster.
The deduction was claimed on qualifying property as described above as general bonus depreciation property, plus it could be claimed on nonresidential real property and residential rental property. Qualifying property must be placed in service by the end of the third calendar year following the disaster date (or, by the fourth calendar year if it is nonresidential real or residential rental property).
If a binding contract to acquire the property existed before the date of the disaster, the property did not qualify. Also, to qualify, substantially (80% or more) of the property’s use must be in the active conduct of the business located in the federally declared disaster area. ●● Qualified Recovery Assistance property: The Food, Conservation, and Energy Act of 2008 provided relief for victims of the severe storms and tornadoes that decimated the Kiowa County, Kansas, area in May 2007. Qualifying property must be acquired after May 4, 2007, and placed in service in the Kansas disaster area before 2009 (or before 2010 if it is nonresidential real or residential rental property). (See IRS Pub 4492-A for more information.)
The deduction was claimed on qualifying new property as described earlier as general bonus depreciation property, plus it could be claimed on nonresidential real property and residential rental property. The property could not be acquired under a written binding contract in effect before May 5, 2007. Substantially all of the use of the property must be in the Kansas disaster area.
Calculation of Basis for Bonus Depreciation The key to correctly calculating the amount of bonus depreciation is determining the asset’s basis that is eligible for the deduction. The basis on which to claim the deduction is: times less less
Cost Business & Investment-Use % Section 179 Expense Credit Reductions (for example, the disabled access credit)
Adjusted Basis for Bonus Depreciation
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After the bonus depreciation amount is deducted, depreciation is calculated on any remaining basis.
AMT Depreciation Adjustment The deduction for bonus depreciation is also allowed for Alternative Minimum Tax (AMT) purposes. In fact, businesses that are subject to AMT are exempt from the AMT depreciation adjustment on any qualifying property on which they claim bonus depreciation. Not only is bonus depreciation allowable for AMT purposes, but when the asset’s remaining basis is depreciated for regular tax purposes, the same depreciation deduction is allowed for both regular and AMT tax purposes. Be aware, therefore, if you elect not to claim bonus depreciation and you are subject to AMT, such property is not exempt from the AMT depreciation adjustment.
Election Not to Claim Bonus Depreciation The deduction for bonus depreciation is not optional. If you do not want to claim the deduction on eligible property, you must make a formal election to that effect. If you fail to make the election and do not claim the additional first-year depreciation, then the property is nonetheless treated as if you had claimed the additional depreciation amount. In such a situation, you will never be able to depreciate the asset’s entire basis because before calculating depreciation each year on the asset, you must first reduce its basis by the deduction that you did not claim! You make the election not to claim bonus depreciation by attaching a statement to the tax return. The election must be made by the due date (including extensions) of your tax return. Once the election is made, it generally may be revoked only with the written consent of the Commissioner of Internal Revenue. While you cannot make the election not to claim the deduction on an asset-by-asset basis, you can elect not to claim it for any class or classes of assets. Simply indicate which class (for example, all 5-year assets) or classes on the election statement. When the election is made, it applies to all property in that class placed in service during that tax year. The election is made each year for newly acquired assets if you do not want to claim the deduction.
Election to Claim 50% Bonus Depreciation Instead of 100% Bonus As long as the taxpayer does not make the election not to claim bonus depreciation (see the previous section entitled “Election Not to Claim Bonus Depreciation”), the taxpayer may elect to deduct 50%, instead of the 100%, bonus depreciation for any class or classes of qualifying assets. This election is only available for a tax year that includes September 9, 2010. The election must be made by the due date (including extensions) of your tax return for the year that includes September 9, 2010. It is made in the same manner as the election not to claim bonus depreciation and, therefore, cannot be made on an asset-by-asset basis. This election is allowed per Revenue Procedure 2011-26. If, on or before April 18, 2011, a taxpayer has already timely filed its federal tax return for the tax year that includes September 9, 2010, there is an automatic 6-month extension from the due date of that return (excluding extensions) to make this election to claim 50% bonus depreciation instead of the 100%
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depreciation deduction. To make the election, the taxpayer must file an amended return and attach an election statement indicating it is filed pursuant to IRS Reg. 301.9100-2 (b).
Retroactive Application of 50% Bonus Depreciation The Small Business Jobs Act of 2010, which was signed into law on September 27, 2010, retroactively extended 50% bonus depreciation for qualifying property placed in service in 2010. Because the Act was signed so late in the year, many taxpayers were unable to take advantage of it. In response, the IRS, in Revenue Procedure 2011-26, has decided to allow taxpayers to retroactively apply 50% bonus depreciation to qualifying property placed in service after 2009 on the following tax returns: ●● 2009 tax returns for years that began in 2009 and ended in 2010, and ●● 2010 tax returns for short years that began and ended in 2010. As long as the taxpayer did not make the election not to claim bonus depreciation on such tax returns, the taxpayer may now claim 50% bonus depreciation by filing either: ●● An amended tax return that is filed before the taxpayer files its tax return for the first tax year succeeding the 2009 tax return or the 2010 short tax year return, or ●● Form 3115, Application for Change in Accounting Method, with the taxpayer’s timely filed tax return for the first or second year succeeding the 2009 tax year or the 2010 short year return. However, to file Form 3115, the taxpayer must still own the property as of the first day of the year of the change. However, such a taxpayer will be treated as if the election not to claim bonus depreciation had been filed as long as the taxpayer: ●● Deducted depreciation (other than bonus depreciation) on that return, and ●● Does not file either an amended return or a Form 3115, as described above, to claim bonus depreciation. And, finally, if the taxpayer timely filed either the 2009 or the 2010 return as described above, and elected not to claim 50% bonus depreciation for a class of property, the taxpayer may now revoke that election as long as an amended return is filed by the later of June 17, 2011, or before filing a return for the first year succeeding the 2009 return or 2010 short year return.
Accounting Method Changes for Claiming Bonus Depreciation The IRS regulations specify which changes to depreciation and amortization constitute a change in accounting method under IRS Code Section 446, General Rule for Methods of Accounting. Depreciation is generally considered a method of accounting. As explained in the previous section, the IRS is allowing taxpayers to retroactively apply 50% bonus depreciation to qualifying property placed in service after 2009 on certain 2009 and 2010 tax returns. The taxpayer may either file an amended return or an accounting method change to do so. In addition to this, there are several other changes to or from claiming bonus depreciation that are also considered to be a change in accounting method, but only under certain circumstances: ●● A change from not claiming bonus depreciation to claiming it provided the taxpayer didn’t elect out of it (this was for 2000 and 2001 returns and then again was allowed for certain tax returns in 2006).
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●● A change from claiming the 30% bonus depreciation to claiming the 50% bonus depreciation, or vice versa. ●● A change from claiming bonus depreciation to not claiming it if the asset doesn’t qualify.
Luxury Vehicles and Bonus Depreciation The allowable amount of depreciation on a luxury vehicle (defined in Section 280F(d)(5)) on which bonus depreciation is claimed is increased if the vehicle is placed in service in 2008 through 2012. This additional depreciation, up to $8,000, is only for the year in which the vehicle is placed in service. For a qualifying luxury automobile placed in service in either 2011 or 2010, you may deduct up to $11,060 ($3,060 regular limit + $8,000 additional allowance) of depreciation for the placed-in-service year. If the vehicle is a truck or van built on a truck chassis (including SUVs), then the maximum allowable depreciation, if placed in service in 2011, is $11,260 ($3,260 regular limit + $8,000 additional allowance) and, if placed in service in 2010, it , is $11,160. Qualifying luxury automobiles placed in service in either 2009 or 2008 may claim a maximum depreciation deduction of $10,960 in the placed-in-service year and qualifying trucks and vans placed in service in either 2009 or 2008 may claim a maximum depreciation deduction of $11,060 in the placed-in-service year. The additional amount of depreciation is available only if you did not elect out of bonus depreciation for 5-year property and if the property qualifies as bonus depreciation property (that is, it can’t be used property, for example). Furthermore, if the business use of the vehicle falls to 50% or less, the additional depreciation claimed is subject to recapture. For luxury vehicles that qualify for 100% bonus depreciation (that is, those acquired and placed in service after September 8, 2010, and before January 1, 2012), there was an unusual result in the calculation for the first five years following the placed-in-service year. If calculated under prior rules, no depreciation would have been allowed in those years. To mitigate this result, Revenue Procedure 2011-26 provides a safe harbor method of accounting for these vehicles. Under the safe harbor method of accounting, as before, in the placed-in-service year, the taxpayer deducts the lesser of 100% bonus depreciation or the maximum annual amount allowed. However, in the years following the placed-in-service year, the taxpayer should calculate depreciation as if 50% bonus depreciation had been applied, subject to the maximum allowable limits.
Long-Term Contracts and Bonus Depreciation The Small Business Jobs Act of 2010 allows bonus depreciation on assets with a recovery period of seven years or less to be disregarded when computing the percentage-of-completion for long-term contracts. In other words, the cost of qualified property taken into account as a cost allocated to the contract is to be calculated as if bonus depreciation had not been claimed but rather MACRS had been applied to its entire depreciable basis. This applies to such property placed in service after 2009 and before 2011 (before 2012 for longer-production-period property). This will allow contractors to benefit from bonus depreciation even if they do not finish a contract within the same year.
Short Tax Years If at any time there is a short tax year of less than 12 months during which you place qualifying property in service, the full amount of the bonus depreciation may still be claimed. There is no proration required.
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Mid-Quarter Convention In order to determine if the mid-quarter convention applies, you need to calculate if more than 40% of the total depreciable basis of qualifying property is placed in service during the last three months of the year. For this purpose, do not reduce the basis of such property by the bonus depreciation deduction.
States and Bonus Depreciation Whenever there is a change to federal tax law, it is necessary to look at each of the states and see whether or not they have chosen to follow it, in whole or in part. This is particularly true of the deduction for bonus depreciation as many states have chosen to decouple from the federal rules. For additional information, refer to the article State Conformity with Federal Bonus Depreciation Rules on the BNA Software web site.
Electing Out of Bonus Depreciation for Refundable Credits The Housing and Economic Recovery Act of 2008 allows corporations to forgo the bonus depreciation deduction and instead increase the credit limitations on both the Section 38 (c) General Business Credit for research expenditures and the Section 53(c) Alternative Minimum Tax credit. This provision under IRS Code Section 168(k)(4), which was extended by the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010, applies to corporations (and certain automotive partnerships) with tax years ending after March 31, 2008. It is known as a Section 168(k)(4) election. To learn more about the Section 168(k)(4) election, download the free White Paper: Electing Out of Bonus Depreciation for Refundable Credits from the BNA Software web site.
Bonus Depreciation vs. Section 179 Expense A primary goal of tax planning is to maximize your deductions. If you are able to claim either bonus depreciation or Section 179 expense on an asset, which is better? Actually, you may be able to claim them both and, in fact, you may be able to claim both on the same asset.* This section of the Resource Guide looks at both the similarities and dissimilarities of these two deductions. Deciding which provision to apply to which assets to give the taxpayer the most benefit is important for good tax planning. With the current increase in Section 179 limits, more businesses than ever can now benefit by claiming it. For tax years beginning in 2010 and 2011, one can claim a maximum Section 179 expense of up to $500,000 and that amount is not reduced until the cost of Section 179 property that is placed in service in the year exceeds $2,000,000.
*Note: If claiming both Section 179 expense and bonus depreciation on the same asset, the Section 179 amount reduces the asset’s basis first, before bonus depreciation can be calculated.
Similarities Both bonus depreciation and Section 179 expense are claimed on qualifying fixed assets and both are optional. You don’t have to claim either even if the asset qualifies. However, in this aspect they are, in fact,
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somewhat different because if you do not want to claim bonus depreciation, you must elect to opt out of it. If you do not want to claim Section 179, you simply don’t claim it. Both deductions are claimed on IRS Form 4562, although on different lines. However, the two amounts are ultimately combined on the last line of the form and entered as a combined amount on your income tax return as “depreciation expense.” There is a maximum amount of depreciation that can be claimed on luxury vehicles under Section 280F. For this purpose, “depreciation” includes both Section 179 expense and bonus depreciation. In other words, you cannot claim either Section 179 or bonus depreciation in addition to the allowable depreciation amount. (In most instances, therefore, there is no point in claiming Section 179 expense on a luxury vehicle as the amount of depreciation without any Section 179 usually exceeds the allowable amount.) Both bonus depreciation and Section 179 expense are claimed on qualifying property in the year in which the property is placed in service and only in that year. Furthermore, neither deduction is reduced if there is a short tax year of less than 12 months.
Differences There are many more differences than similarities when it comes to these two deductions. The following points represent significant differences between the deduction for bonus depreciation and that for Section 179 expense: ●● New versus used property: Bonus depreciation can only be claimed on property whose original use by the taxpayer claiming the deduction begins on or after the effective date. Bonus depreciation may also be claimed on any additional costs that the taxpayer may expend to recondition or rebuild the original property. However, if the taxpayer purchases reconditioned or rebuilt property, such property does not qualify for the deduction. If the newly acquired property contains used parts, it will still be treated as new property as long as the cost of the used parts is not more than 20% of the cost of the property (Reg. 1.168(k)-1(b)(3)(i)). Section 179 expense can be claimed on new or used property, although the property must be acquired by purchase (and not from a related party). ●● Qualifying property: While certain property can qualify for both bonus depreciation and Section 179 expense, other property may only qualify for one of them. Generally, depending on its placed-inservice date, the following property qualifies for bonus depreciation: »» MACRS property with a recovery period of 20 years or less, »» Computer software that is not Section 197 property (that is, software that is defined in Section 167(f)(1)(B)), »» Water utility property, or »» Qualified leasehold improvement property (generally, this includes most leasehold improvements made to nonresidential real property that are placed in service more than three years after the building was initially placed in service). In addition to the above, certain aircraft and some assets having longer production periods can qualify for bonus depreciation. Certain nonresidential real property or residential rental property may also qualify for bonus depreciation depending on its location (such as GO Zone property). Best Practices in Fixed Assets Management A Resource Guide for Claiming Bonus Depreciation
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Generally, Section 179 property is any tangible Section 1245 property. It includes certain offthe-shelf computer software but does not include air conditioning or heating units. Furthermore, qualifying Section 179 property does not include property ineligible for the earlier Investment Tax Credit, such as any property which is used predominantly to furnish lodging. As you can see, generally the same property qualifies for both of these deductions. It is the exception, rather than the rule where specific property won’t qualify for both deductions. For example, property used predominantly to furnish lodging may qualify for bonus depreciation but not for Section 179 expense. ●● Taxable income limit: The amount of Section 179 expense deducted may not exceed the entity’s income from the conduct of an active trade or business for the year. To calculate the limit, taxable income is calculated without any Section 179 expense and before any net operating loss carryforward or carryback. Note that any excess Section 179 amount claimed but not deducted may be carried forward indefinitely. There is no such limit on the amount of bonus depreciation that may be claimed and, in fact, the deduction for bonus depreciation may create a net operating loss for the year. ●● Active trade or business: As explained above, the taxable income limit for deducting Section 179 expense is based on the entity being involved in an active trade or business. The definition of a trade or business is a for-profit activity for which ordinary and necessary expenses are deductible under Section 162. Simply holding property for the production of income is not considered a trade or business for this purpose. A taxpayer is considered to actively conduct a trade or business if the taxpayer participates in its management or operations in a meaningful way. Sole proprietors, for example, cannot deduct Section 179 expense for a business they own unless they actively participate in it. There is no similar requirement for a business deducting bonus depreciation. ●● Limit on dollar amount: Whereas there is a stated dollar limitation for Section 179 expense (based on the year in which the tax year begins and in which the qualifying property is placed in service), the only limit on the dollar amount of bonus depreciation is that it is generally 50% of the adjusted depreciable basis of the asset.* (One such adjustment to the asset’s depreciable basis is the reduction for any Section 179 expense claimed.) For tax years beginning in 2010 and 2011, the allowable amount of Section 179 expense is $500,000. For tax years beginning in 2012, the allowable amount of Section 179 expense will be reduced to $125,000, indexed for inflation.
*Note: The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 temporarily increased, to 100%, the bonus depreciation deduction for qualifying property placed in service after September 8, 2010, through 2011 (through 2012 for certain aircraft and long-production-period property).
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●● Investment limit: For every dollar over a stated amount invested in qualifying Section 179 property placed in service during the year, the allowable Section 179 expense is reduced dollar for dollar. For tax years beginning in 2010 and 2011, the allowable Section 179 expense is reduced by the amount by which the cost of qualifying Section 179 property exceeds $2,000,000. For tax years beginning in 2012, the investment limit will be $500,000, indexed for inflation. There is no investment limit when claiming the bonus depreciation deduction. ●● Sport utility vehicles (SUVs): There is a $25,000 cap on the amount of Section 179 expense that may be claimed on certain sport utility vehicles (SUVs). This amount is not indexed for inflation. To qualify for this limitation, the vehicle must be designed to carry passengers over public streets, cannot be a luxury vehicle under Section 280F, and must have a gross vehicle weight of 14,000 pounds or less (as long as it is more than 6,000 pounds). There is no such limit when claiming bonus depreciation on SUVs. ●● Noncorporate lessor: There is an exception under IRS Section 179(d)(5), which prohibits a noncorporate lessor from claiming the Section 179 expense deduction unless the taxpayer satisfies one of two requirements: »» The property must have been manufactured or produced by the lessor, or »» The lease term, including options to renew, is less than 50% of the property’s class life and the Section 162 expenses with respect to the property (other than rents or reimbursed amounts for the property) exceed 15% of the property’s rental income for the first 12 months of the lease. There are no noncorporate lessor rules for claiming the bonus depreciation deduction. ●● Effective Date: The amount of the allowable Section 179 expense deduction depends on the year in which the taxpayer’s fiscal year begins and in which the property is placed in service. The deduction for bonus depreciation is effective for qualifying property placed in service after December 31, 2007, and before January 1, 2013 (although certain property can be placed in service up until January 1, 2014). Furthermore, certain property, such as GO Zone or New York Liberty Zone property, has its own effective dates. ●● Recapture: When an asset is disposed of, any gain realized is recaptured as ordinary income to the extent of both bonus depreciation and any Section 179 claimed. However, if the business use of an asset decreases to 50% or less before the end of the asset’s recovery period, any Section 179 expense amount claimed is subject to recapture, but this does not apply to bonus depreciation.
Considerations for Claiming Bonus Depreciation There are a number of challenges associated with claiming bonus depreciation: ●● The need to determine which assets qualify for the bonus depreciation deduction,
Best Practices in Fixed Assets Management A Resource Guide for Claiming Bonus Depreciation
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●● The need to calculate the bonus depreciation amount (which may be 30%, 50%, or 100%) and correctly apply the bonus depreciation rules for qualifying assets, based on their placed-in-service date, ●● The need to select the class or classes of assets on which you want to claim bonus depreciation, ●● The need to run a report to determine the amount of bonus depreciation claimed for a given year, ●● The need to be able to determine if luxury vehicles can or cannot claim additional depreciation if bonus depreciation is applied, ●● The need to know whether certain property (such as GO Zone property) qualifies for bonus depreciation, ●● The need to decide whether you should apply bonus depreciation and/or Section 179 to an asset, ●● The need to determine if the state income tax return allows bonus depreciation to be claimed, and ●● The need to correctly determine the basis and gain/loss amounts for assets on which bonus depreciation is claimed. The risk of errors, noncompliance, and inefficiencies involved with fixed assets management and tax depreciation calculation increases significantly when organizations rely upon manual process and spreadsheets rather than expert tax systems to enforce their fixed assets policies. This may occur as a result of insufficient documentation of depreciation policies, as well as the lack of standardized enforcement. In many organizations, staff members responsible for the data entry associated with fixed assets, must manually enter the necessary data for each asset acquired (e.g., property type, asset life, depreciation method, averaging convention, and any allowable bonus depreciation and Section 179 expense). Unfortunately, these staff members may not be sufficiently knowledgeable of all of the current fixed assets depreciation rules for both financial and tax reporting, increasing the risk of calculation errors and regulation noncompliance. As tax regulations have continued to evolve during the past several years, bonus depreciation compliance has become much more complicated. Bonus depreciation has been allowed on a wide range of very specific asset types that change over time and that have different effective dates. The allowable bonus depreciation amount changes from 30% to 50% to 100% and then back to 50%. The fact that bonus depreciation was allowed to expire, was then reintroduced, and later extended three times, indicates that it is imperative that organizations which make use of these provisions know what the rules are when depreciating their fixed assets and have the enforceable policies, procedures, and expert tax systems in place to ensure compliance and take full advantage of available tax savings.
Best Practices in Fixed Assets Management A Resource Guide for Claiming Bonus Depreciation
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BNA Fixed Assets™ Solutions BNA Fixed Assets provides you with the ability to document your depreciation and amortization policies (including bonus depreciation) through Asset Type templates and allows you to automate the enforcement and implementation of these policies when performing data entry for fixed assets. This eliminates potential errors from misclassifying assets, automates the process of entering assets, enforces the use of a company’s depreciation and amortization policies, greatly reduces the volume of data required to enter each asset in the system, and, above all, guarantees compliance with GAAP rules and IRS regulations. BNA Fixed Assets provides automatic annual updates of its fixed assets management software. What’s more, BNA Fixed Assets solutions speed the data entry process by allowing you to copy and paste data for multiple assets from an Excel spreadsheet into BNA Fixed Assets, for greater efficiency and accuracy. With BNA Fixed Assets, you’ll benefit from having the best solution available on the market today to maximize productivity, comply with GAAP rules and IRS regulations, and meet all of your financial and tax reporting requirements. Learn more about BNA Fixed Assets at www.bnasoftware.com/fixedassets.
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About Nancy Faussett Nancy Faussett, CPA, has over 25 years of tax accounting experience. With BNA Software since 2001, Nancy serves as in-house expert on fixed assets, depreciation, and various areas of corporate and individual income taxation. Nancy has also been published in Strategic Finance and the ACT Journal. Previously she was vice president of tax preparation for General Business Services and later worked as a depreciation and tax specialist. Visit us at http://www.bnasoftware.com or call 800-424-2938 (option 3) to speak with a sales representative. Though intended to provide accurate and authoritative information, this publication is provided with the understanding that it does not constitute tax, legal, accounting, or other professional advice or service. This publication may not be reproduced, stored in a retrieval system, or transmitted in whole or in part, in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise, without the prior written permission of BNA Software, 1801 S. Bell Street, Arlington, VA, 22202. ©2011 BNA Software, a division of Tax Management Inc., Arlington, VA. All rights reserved. All company and product names may be trademarks of their respective owners. FA002-RG3-2010 56-7479 0511
Best Practices in Fixed Assets Management A Resource Guide for Claiming Bonus Depreciation
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