ALERT - Congress Passes Legislation Doubling Deduction for 2008 New Equipment PurchasesPrint PDFShare
In February, Congress passed legislation doubling the available deduction for purchases of new equipment in 2008 and providing for 50% additional first year depreciation for equipment placed in service during 2008. Separately or in combination, these provisions can create substantial tax savings in 2008 to taxpayers who purchase capital equipment.
Expensing the Cost of New Capital Equipment
Under current law, certain taxpayers can elect to deduct up to $128,000 of the cost of capital equipment (“Section 179 property”) that they purchase and place in service in an active trade or business. In the absence of making such an election, the taxpayer must recover the cost of that property through depreciation deductions over the life of the property (e.g., 3 years, 5 years, 7 years, etc.). The maximum deduction is reduced dollar for dollar by the amount of Section 179 property purchased in excess of $510,000 during the year.
The new law increases the amount that can be deducted in the year the property is placed into service from $128,000 to $250,000. The $250,000 cap is reduced by the amount by which the cost of Section 179 property placed in service during the year exceeds $800,000. Accordingly, if, during a tax year, a taxpayer places Section 179 property in service with a total cost of $850,000, then the cap of $250,000 would be reduced by $50,000. The increases under the new law did not increase the amount that can be deducted for purchase of a qualifying SUV purchase which remains capped at $25,000. 1
Another limitation applicable to the Section 179 expense deduction is that it cannot exceed the aggregate amount of taxable income which is derived from the active conduct by the taxpayer of any trade or business during such taxable year. Thus the expense cannot be used to offset passive income or portfolio investment income.
Generally, in order to take the Section 179 deduction, the following requirements must be met:
1. The property must be “Section 179 property”. Section 179 property generally speaking is non-real estate tangible property such as machinery and equipment, some depreciable computer software and a host of other special purpose real estate improvements used in manufacturing, refining, transportation, utility services, agriculture, etc. Explicitly excluded is property used outside the U.S., property used to furnish lodging (other than hotels and motels), and air conditioning or heating units.
Note: Significant limitations apply to Section 179 property that the taxpayer leases to others.
2. The property (new or used) is purchased and placed in service after December 31, 2007. There are certain limitations placed on property that is acquired pursuant to a binding contract entered into before 2008 or is acquired from related parties.
Subject to the applicable limits described above, if the foregoing requirements are satisfied, the taxpayer who acquires a $250,000 piece of equipment can deduct the entire $250,000 purchase price in the year of purchase rather then deducting the cost of the equipment over several years. 2
Under the new law, taxpayers can take additional first year depreciation deductions equal to 50% of the cost of qualifying property purchased and placed in service in 2008.3
Example: Assume that in 2008, the taxpayer purchases new depreciable five-year property for $100,000. Assume the property does not qualify as Section 179 property. Assume further that the property is subject to the “half-year” convention, meaning that regardless of when during the year the property is placed in service it is assumed that it is placed in service at the midpoint of the taxable year (i.e., for calendar year taxpayers July 1). The amount of the additional first-year depreciation allowed under the new law is $50,000. The remaining $50,000 of the cost of the property is deductible under the rules applicable to a five year property. Thus, 20% or $10,000, is also allowed as a depreciation deduction in the first year. 4 Accordingly, the total depreciation deduction with respect to the property for 2008 is $60,000. The remaining $40,000 of cost of the property is recovered under the otherwise applicable rules for computing depreciation.
There are no adjustments to the allowable amount of depreciation for purposes of the alternative minimum tax.
Generally, in order to qualify for the 50% bonus depreciation the following requirements must be met:
1. The property must have a depreciable life of 20 years or less (in other words, it is generally machinery, equipment, other non-real estate capital equipment and certain qualified leasehold improvements).
2. The taxpayer makes the original use of the property in 2008 (i.e., the property is new, not used).
3. The taxpayer purchases the property and places it in service during 2008.
The new law also increases by $8,000 the limits on depreciation in the first year for automobiles used for business. 5
While each of these provisions create significant incentives individually, the tax savings can be compounded when both incentives are applied to the same equipment purchases. Bonus depreciation can be deducted on property with respect to which the taxpayer takes the Section 179 expense. The bonus depreciation is calculated on the cost of the property as reduced by the amount of the Section 179 expense deducted.
Example: Assume in 2008, a taxpayer purchases and places into service in its business new computer hardware with a cost of $750,000 (and no other Section 179 property). The taxpayer could elect to deduct $250,000 of the cost as a Section 179 expense, it could claim additional first year depreciation of 50% of the remaining cost or $250,000 (($750k - $250k) x 50%), and deduct regular depreciation of $50,000 and thereby deduct a total of $550,000 of the $750,000 purchase price.
Any U.S. Federal tax advice contained in this communication (whether distributed by mail, email or fax) is not intended or written to be used, and it cannot be used by any person for the purpose of avoiding U.S. Federal tax penalties or for the purpose of promoting, marketing or recommending any entity, investment plan or other transaction. (The foregoing legend has been affixed pursuant to U.S. Treasury Regulations governing tax practice.)
1 These caps are increased for property placed in service in an enterprise zone, renewal and the GO Zone.
2 Although Minnesota has recently conformed to all federal changes made between May 18, 2006 and February 13, 2008, including the Economic Stimulus Act of 2008, Minnesota has not conformed to the “Section 179 Property” expensing. Rather, Minnesota has retained its current law requirement that taxpayers add-back to taxable income 80% of the additional expensing in the first year, and then subtract one-fifth of the amount added back in each of the five following tax years.
3 The new law also increased by $8,000 the limits on depreciation in the first year for automobiles used for business. For automobiles (not trucks or vans) that meet those requirements, the caps on depreciation are as follows: (i) $10,960 for the placed in service year; (ii) $4,800 for the second tax year; (iii) $2,850 for the third tax year; and (iv) $1,775 for each succeeding year.
4 This deduction is computed as follows. Five- year property is depreciated on the “double declining balance” method which allows the taxpayer to take a depreciation deduction equal to 40% (i.e., twice the straight line depreciation) of the remaining basis, which in this case, would be $20,000 (i.e., $50,000 x 40%). However under the half-year convention, the property is treated as only in service for half the year and accordingly the taxpayer is entitled to half of the otherwise available deduction or $10,000.
5 Similar to the add-back for “Section 179 Property”, Minnesota has not conformed to the increased bonus depreciation. Rather, Minnesota has retained its current law requirement that taxpayers add-back to taxable income 80% of the additional depreciation in the first year, and then subtract one-fifth of the amount added back in each of the five following tax years.