|January 6, 2014|
Previously published on December 2013
As 2013 ticks to a close, so do several tax incentives available to farmers and other taxpayers who use personal property in a trade or business or hold it for the production of income. Two of the most important are the ability to expense and immediately write off the cost of depreciable personal property and the ability to claim additional 50% “bonus” depreciation on qualifying property. These benefits expired at the end of 2012 but the American Taxpayer Relief Act of 2012 (signed into law in 2013), retroactively reinstituted these benefits through the end of this calendar year. Although accelerating expensing and depreciation deductions do not increase the total amount a business can write off for a given investment, it does allow a business to deduct more of the cost now and less in the future, and the time value of the resulting tax deferral can translate into substantial savings for the taxpayer. However, beginning January 2014, these tax benefits will disappear without further legislative action. This article explains these benefits in a little more detail.
Generally, amounts spent in connection with the acquisition of personal property, like equipment and machinery, must be capitalized and the cost recovered for tax purposes as “cost recovery” (i.e., depreciation) deduction under Section 168 of the Internal Revenue Code according to fixed depreciation schedules. However, in order to spur investment, Congress enacted Section 179 of the Code which allows a taxpayer to elect to expense (rather than capitalize and depreciate) certain depreciable personal property in the year those assets are placed in service. The general rules under Section 179 limit that the maximum amount allowed to be expensed to $25,000, which amount is reduced dollar for dollar by the amount of new property that exceeds $200,000. To qualify as “Section 179 property,” the property must be acquired by purchase for use in the active conduct of a trade or business. Property which is merely held for the production of income does not qualify for this election. The Section 179 deduction cannot exceed the aggregate taxable income of the activity, although any deduction not allowed due to this income limitation is carried forward.
In response to the economic crises beginning in 2007, Congress put in some temporary amendments to Section 179 that increased the amount that could be expensed to the current $500,000 and increased the phase-out threshold to $2,000,000. In other words, the $500,000 immediate tax write off was reduced dollar for dollar by the amount of new purchases exceeding $2,000,000 and is fully phased out once those purchases exceed $2,500,000. Importantly, that increase from $25,000 to $200,000 is only temporary. As of January 1, 2014, it retreats back to the $25,000 amount and, while that $475,000 reduction is not a lost tax benefit (the amount may still be recovered over a period of years by claiming a depreciation/cost recovery deduction), the time value of that lost deferral can be substantial.
The 50% first year bonus depreciation is another tax benefit available for tangible property acquired and placed in service before the end of 2013. A 50% bonus depreciation allowance would mean that businesses could immediately deduct 50 cents of every dollar spent on qualifying investment purchases. The remaining 50 cents would be deducted according to regular depreciation schedules. Taxpayers should also be aware that the election to expense a portion of the purchase utilizing Section 179 reduces a taxpayer’s tax basis in that asset and, as a result, the amount available for the 50% bonus and regular depreciation deductions.
Property with a recovery period of 20 years or less, qualified leasehold improvements, certain computer software and water utility property are eligible for bonus depreciation. This would also include certain real property assets, such as machine sheds and shops, if constructed and placed in service by December 31, 2013. Unlike Section 179 expensing, only new property is eligible for bonus depreciation but net income is not required to take the bonus depreciation deduction.
Both the Section 179 expensing allowance and bonus depreciation have been extended several times by Congress over the past few years as attempted economic stimulus actions. For example, first year bonus depreciation was authorized following the terrorist attacks on 9/11/2001. Based upon Congress’ past practice of “extending” these and other tax benefits, practitioners are hopeful that this will happen again but hope is not a good tax planning strategy, especially in the current political environment. Farmers and other taxpayers, therefore, should look into these tax benefits and, if appropriate to their particular business and tax situation, act now to take advantage of the opportunity to realize significant tax savings by being able to immediately write off a substantial portion of the cost of acquiring a needed capital asset.