Year-End Planning: Buying and Writing Off Fixed Asset Additions
The end of the tax year is rapidly approaching for calendar year businesses and time is running out to analyze the best method for recovering the cost of assets that you've acquired during the year. It’s also the time to consider whether it makes sense to purchase machinery and equipment before the end of the year or defer those purchases until 2013.
“Bonus depreciation” is a cost recovery incentive option for 2012 asset additions, but unless extended by new legislation, will essentially disappear for 2013. Businesses generally have two ways to recover the cost of asset purchases: (1) tax depreciation under the Modified Accelerated Cost Recovery System (MACRS), and (2) the election to expense the cost of assets under Internal Revenue Code Section 179 (Sec. 179).
Taking Advantage of the Sec. 179 Expensing Limits for 2012
Under Code Sec. 179, most small business taxpayers can elect to deduct as an expense, rather than depreciate, up to a specified amount of the cost of new or used tangible personal property placed in service during the tax year in the taxpayer’s business. The maximum annual expensing amount generally is reduced dollar-for-dollar by the amount of Sec. 179 property placed in service during the year in excess of a specified investment ceiling. The amount eligible to be expensed for a tax year can’t exceed the taxable income derived from the taxpayer’s active conduct of a trade or business. Any amount that is not allowed as a deduction because of the taxable income limitation may be carried forward to future tax years.
Expense and investment limits for 2012. For tax years beginning in 2012: (1) the dollar limitation on the expense deduction is $139,000; and (2) the investment-based reduction in the dollar limitation starts to take effect when property placed in service in the tax year exceeds $560,000 (the investment ceiling) and phases out completely when the cost of eligible property reaches $699,000. The limits are much less generous than the $500,000 expensing limit and $2,000,000 investment ceiling that applied for 2010 and 2011. However, the 2012 limits are far more generous than the limits scheduled to apply for tax years beginning in 2013: a $25,000 expensing limit, and a $200,000 investment ceiling.
It is important to note that there is no pro rata reduction of the Sec. 179 deduction depending on the portion of the year the asset is held. If the deduction is allowable, the amount that may be expensed is the same regardless of when the property is acquired during the year.
Taxable income limit. The Sec. 179 expensing deduction is limited to taxable income from any of the taxpayer’s active trades or businesses, including compensation earned as an employee. This means that the taxable income limit doesn’t bar an expense deduction just because the specific business in which the property is used doesn’t generate positive taxable income. As long as the taxpayer has aggregate net income from all his trades or businesses, the deduction is allowed. In general, any amount that cannot be deducted because of the taxable income limit can be carried forward to later years until it is fully deducted.
Assets eligible for expensing. In general, property is eligible for Sec. 179 expensing if it is:
- New or used tangible personal property that’s Code Sec. 1245 property (generally, machinery and equipment), depreciated under the MACRS rules of Code Sec. 168 and acquired for use in an active trade or business.
- Also, if placed in service in a tax year beginning before 2013, off-the-shelf computer software qualifies for the election.
Claim 50% Bonus Depreciation
Under current law, a 50% bonus first-year depreciation allowance applies to qualified property acquired and placed in service after December 31, 2011 and before January 1, 2013 (before January 1, 2014 for certain specialized property).
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 Sec. 179 expensing is claimed on qualified property, the amount expensed is taken first before the additional 50% first-year depreciation allowance is computed. Then the taxpayer computes regular depreciation with reference to the adjusted basis remaining after expensing and after the additional 50% bonus amount. There is no alternative minimum tax (AMT) depreciation adjustment for property written off using bonus depreciation. Also, as with Sec. 179, the bonus depreciation amount is determined without any pro-ration based on when during the year the property is acquired.
Property qualifying 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 MACRS rules apply with a recovery period of 20 years or less; “off the shelf,” computer software; qualified leasehold improvement property; or certain water utility property.
- It is placed in service before January 1, 2013.
- Its original use commences with the taxpayer (i.e., it is “new” property).
The 50% first-year depreciation allowance is mandatory; it 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.
Special Rules for Vehicles. If bonus depreciation ends at the close of 2012, so will the generous first-year dollar limit on autos, light trucks, and vans subject to the “luxury auto” rules. Under the bonus depreciation rules, the first-year depreciation deduction for new vehicles that qualify is $8,000 more than the first-year depreciation limit that would otherwise apply.
Buying and Writing Off Fixed Asset Additions
For new vehicles bought and placed in service in 2012, and that qualify for bonus depreciation, the enhanced first-year dollar limit is $11,160 for autos (not trucks or vans) and $11,360 for light trucks or vans. 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. Under current law, the increased deduction amounts apply only to vehicles placed in service before 2013. Therefore, businesses thinking of buying a new auto, light truck or van should buy the vehicle and place it in service this year if they want to maximize first-year deductions.
Heavy trucks and 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. Under Sec. 179, not more than $25,000 of the cost of a heavy SUV may be expensed under Code Sec. 179. The balance of the heavy SUVs cost may be depreciated under the regular rules that apply to five-year MACRS property. However, with the 50% first-year bonus depreciation also available for qualified assets placed in service in 2012 (in addition to the $25,000 expensing allowance and regular depreciation), businesses 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.
The foregoing discussion is meant to be a very general overview of the bonus depreciation and Sec. 179 rules in effect for 2012. Obviously, each business that is evaluating capital expenditures needs to undertake a detailed analysis based on its specific tax situation. Some of the factors that may need to be considered include:
- The effective tax rate in the year of the cost recovery deduction.
- Will tax rates in the future be higher, making deferred depreciation deductions more valuable?
- Does the business have other tax attributes (e.g., net operating losses) that may expire in the near future?
- Is the business (or its owners) subject to AMT?
- Can bonus depreciation be used to create an NOL that can be carried back to free up tax in prior years?
- Do the states the business operates in allow bonus depreciation/Sec. 179?
- Do the deductions flow through the business to its owners? What is the impact on them?
For additional information, contact the author Mark R. Shellenberger, CPA at [email protected]
Mark R. Shellenberger, CPA