As we approach the last quarter of 2011 and prepare next year’s capital budget, it’s important to ensure that we have taken advantage of all the available tax opportunities in the current year. Currently, there are some favorable tax rules in place that every business needs to be aware of and consider when making decisions to invest in capital expenditures and purchase property and equipment. The current tax law has provided an attractive window of opportunity for businesses to enjoy the current bonus depreciation and expensing rules for capital expenditures. This window of opportunity will be closing soon and the future is unpredictable.
To stimulate the economy, Congress temporarily altered the rules for expensing or depreciating capital assets, allowing accelerated tax deductions for a limited time. In the last few years, these rules have been adjusted several times, however, given the current political and economic climate, it is possible there will not be any more extensions beyond the originally enacted deadlines. Some of the details on what this means and how your business may take advantage of the attractive tax savings are outlined below.
For many businesses, the most visible capital expense is what is spent on vehicles. As you may be aware, there are special rules and depreciation limitations that apply to vehicles. For example, luxury automobiles have a limited amount of depreciation which is capped under regular depreciation, bonus depreciation, and Section 179 expensing rules. In the first year, these limits apply to all passenger autos and to trucks and vans with a gross vehicle weight of less than 6,000 pounds.
LUXURY AUTO CAPS
Regular Regular If Elected,
1st Year 1st Year Bonus
Placed in Service Date Depreciation Depreciation Depreciation
Before Jan 1, 2013 $3,060 $3,160 Additional $8,000
If businesses elect to use Section 179, the limits of $11,060 for vehicles or $11,160 for trucks will apply. Vehicles above the 6,000 pounds gross vehicle weight are exempt from the dollar caps under the luxury auto rules. These vehicles, however, are limited to $25,000 under Section 179 expensing.
Bonus Depreciation: Advantages and Limitations
Originally, Bonus depreciation emerged in the U.S. business arena in 2001 when Congress enacted the law to stimulate the economy after September 11, 2001. Over the past decade we have seen various versions of Bonus depreciation with different percentages and factors. Bonus depreciation can only be applied to new, original-use property and helps a business reduce its taxes in the year of purchase. Under this rule, a taxpayer may take a bonus depreciation allowance in the first year an asset is placed in service at the allowed percentage for qualified assets and deduct large amounts of the capital expenditures, subject to the limitations highlighted below.
Under the regular depreciation rules, the taxpayer can also take depreciation on the remaining basis at the usual rate and method after the bonus depreciation has been taken. Most tangible personal property with a class life less than 20 years, qualified leasehold improvement property, and off-the-shelf computer software are qualified for bonus depreciation. Please note that Federal legislation called “The Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010,” extended and expanded bonus depreciation through 2012.
To determine the percentage of bonus depreciation your business can take and the timing that works best for your business, you can review and use the following table:
|Placed in Service Date||Bonus Percentage|
|Jan 1, 2010 to Sept 7, 2010||50%|
|Sept 8, 2010 to Dec 31, 2011||100%|
|Jan 1, 2012 to Dec 31, 2012||50%|
The 100% bonus depreciation for the rest of 2011 is very attractive and may merit accelerating some capital purchases planned for 2012 into this year. The law allows us to elect out of bonus depreciation, however, such election is only available on a class by class basis. For example, if a taxpayer purchases a piece of construction equipment for $100,000, which is a five-year asset for tax depreciation, and elects out of taking bonus depreciation on that asset purchase, the taxpayer will also be unable to take bonus depreciation on the purchase of another $10,000 small equipment with the same five-year class life asset. The recovery periods under bonus depreciation rule are 3, 5, 7, 10, 15 and 20 years for eligible assets for tax depreciation.
Section 179 Expensing: Advantages and Limitations
Under the current rules, taxpayers can deduct higher amount under Section 179 deduction. The advantage is that the taxpayer deducts the amount elected in the year of acquisition in lieu of taking regular depreciation. New and used assets are eligible for expensing, and it can also be combined with bonus depreciation.
There is a total amount that a taxpayer is entitled to expense under the section 179 Tax code, and the deduction phases out for total capital purchases in excess of a cap. If a company’s total capital expenditures exceed the phase-out amount, the amount eligible to expense under Section 179 is reduced dollar-for-dollar by the amount over the phase-out amount. Section 179 expensing can be elected based on the following limits:
|Tax Year Beginning||Expensing||Amount|
|The 2012 amounts are indexed for inflation.|
The use of Section 179 is limited to the extent that it doesn’t generate a taxable loss, thus if the amount elected for expensing exceeds taxable income, the excess is carried forward separately. Therefore, a net operating loss cannot be created by using Section 179 depreciation expense.
Taxpayers may elect to expense up to $250,000 of qualified real property under Section 179 in tax years beginning in 2010 and 2011, provided such real property is a qualified leasehold improvement, qualified restaurant property or qualified retail improvement property. Off-the-shelf computer software is also eligible for Section 179 expensing under current rules, but such software placed in service will no longer qualify for tax years after 2012 if the legislation is not extended.
Here’s a summary of Bonus depreciation vs. Section 179 expensing:
Bonus depreciation is not limited in amount and taxpayers can use bonus depreciation to create a net operating loss and carry back to prior years perhaps resulting in an immediate tax refund.
Nevertheless, there are circumstances where Section 179 expensing is the preferred method of depreciating property. A taxpayer may take any portion of the expensing election as an immediate deduction, as opposed to bonus depreciation, which must be taken on an entire class life (as previously noted). Finally, expensing is allowed on used property whereas bonus depreciation is only allowed on new equipment.
As you consider the need to invest in capital assets, it is important to analyze the nature and timing of the transactions. Make sure to contact your tax professional to discuss your particular tax situation. There will more than likely be specific exceptions and opportunities in the rules that impact you.
For more information or questions on this topic, please contact your professional at Glenn M. Gelman and Associates at 714-667-2600 or visit us on our website www.gmgcpa.com.