by Bob Rywick
Taxpayers other than trusts, estates and certain non-corporate lessors may elect to expense under Internal Revenue Code § 179 the cost of certain qualified property in the year that property is placed in service, instead of depreciating the cost of the property over several years.
Before the enactment of the Jobs and Growth Tax Relief Reconciliation Act of 2003, the maximum amount that could be expensed for taxable years beginning after 2002 was $25,000. In addition, the maximum annual expensing amount was reduced to the extent that the total cost of qualified property placed in service during the taxable year was more than $200,000.
Thus, no expense deduction was allowed if the total cost of qualified property placed in service during the taxable year was more than $225,000.
Qualified property was considered to be tangible MACRS property that was purchased for use in the active trade or business of the taxpayer. The expensing election was revocable only with the Internal Revenue Service’s consent.
The act substantially changed these rules for taxable years beginning in 2003, 2004 and 2005.
Increased annual expensing amount. The act increases the maximum annual expensing amount to $100,000.
Example 1: Your client, a calendar-year sole proprietor, places $180,000 of qualified property in service during 2003. She can elect to expense $100,000 of the cost of the property and depreciate the balance over the applicable life of the property that was not expensed.
Observation: A taxpayer who wants to maximize the amount of expensing and depreciation deductions that can be claimed during a taxable year should expense qualified property with the longest recovery period and depreciate property with the shortest recovery period.
Example 2: The same facts apply as in Example 1. Of the $180,000 of qualified property placed in service in 2003, $60,000 was for seven-year recovery property and $120,000 was for five-year recovery property. All of the property is eligible for 50 percent bonus depreciation, and the half-year convention applies.
To maximize the total of her expensing and depreciation deductions for 2003, your client should elect to expense all of the seven-year recovery property and $40,000 of the five-year recovery property. She could then take bonus depreciation of $40,000 (50 percent of remaining $80,000 cost of five-year property) plus regular depreciation of $8,000 (20 percent of balance of $40,000 remaining after taking bonus depreciation).
Her total deduction with respect to the $180,000 she spent for qualified property will be $148,000 ($100,000 expensed plus $48,000 of depreciation).
If your client had expensed $100,000 of the five-year property and depreciated the remaining $20,000 of five-year property and the $60,000 of seven-year property, her depreciation deduction would have been $46,287 instead of $48,000.
This equals bonus depreciation of $40,000, plus $2,000 of depreciation on the remaining $10,000 of five-year property, plus $4,287 depreciation on the remaining $30,000 of seven-year property (14.29 percent of $30,000).
Observation: Suppose that in Example 2, your client purchased all of the seven-year property in the fourth quarter, and her purchases in the fourth quarter would cause her to have to use the mid-quarter convention instead of the half-year convention. In that case, she might want to expense some of the seven-year property in order to avoid having to use the mid-quarter convention. Expensed property is not taken into account in determining whether the mid-quarter convention has to be used.
Increase in the amount at which the right to elect to expense qualified property starts to phase out. The act increases the amount at which the maximum annual expensing allowance starts to phase out to $400,000 from $200,000. This means that the right to elect to expense is completely lost when the total amount of qualified property placed in service in the taxable year reaches $500,000 (instead of $225,000 as under pre-act law).
Example 3: Your client, a small corporation that is a calendar-year taxpayer, buys $350,000 of qualified property that it places in service in 2003. Your client is eligible to elect to expense $100,000 of the cost of this property. Under pre-act law, it would not have been able to expense any of the cost since the right to expense would have completely phased out when the cost of qualified property reached $225,000.
Example 4: The same facts apply as in Example 3, except that your client buys $460,000 of qualified property that it places in service in 2003. Your client may elect to expense only $40,000 of the cost of the qualified property ($100,000 less $60,000 [the excess of $460,000 over $400,000]).
As a result of these changes in the IRC ¤ 179 expensing rules, many (probably most) small businesses will be able to claim a full deduction for the cost of their business machinery and equipment in the taxable year that those items are placed in service. This will effectively reduce the cost of those assets.
In addition, filing and record keeping burdens for many businesses will be eased by the opportunity to expense greater amounts. However, record-keeping burdens will not be reduced if separate depreciation records have to be kept for states that do not accept the increase in federal expensing.
The act did not change the rule limiting the amount of the expensing deduction (after application of the phaseout rule) to the amount of taxable income (before taking the cost of qualified property into account and certain other amounts into account) from any of the taxpayer’s active trades or businesses. However, an amount that can’t be deducted because of the taxable income limit may be carried over indefinitely until it can be deducted.
Increase in the expensing amount for certain property. The maximum annual expensing limit is increased to $135,000 for certain qualified zone property, qualified renewal property, and Liberty Zone property, and only 50 percent of the cost of that property is taken into account before subtracting the $400,000 phaseout amount.
Example 5: Your client, a business in lower Manhattan, buys and places into service in 2003 $900,000 of Liberty Zone property. Your client is eligible to expense $85,000 of the cost of that property ($135,000 less $50,000 [the excess of $450,000 (50 percent of $900,000 cost of the Liberty Zone property) over $400,000]).
Indexing for inflation. The act provides that the $100,000 annual expensing limit and the $400,000 amount at which the phaseout of the amount to be expensed begins will be indexed for inflation for taxable years beginning in a calendar year after 2003 and before 2006.
An increase in the $100,000 amount will be rounded to the nearest multiple of $100,000, and an increase in the $400,000 amount will be rounded to the nearest multiple of $10,000.
Off-the-shelf software. The act provides that off-the-shelf computer software that is placed in service in a taxable year beginning in 2003, 2004 and 2005 is qualified property eligible for the IRC ¤ 179 expensing election. To be eligible, the software must be readily available for purchase by the general public, must not be subject to a nonexclusive license, and must not have been substantially modified.
Expensing election. The act allows taxpayers to revoke an expensing election without the service’s consent. Once made, the revocation itself becomes irrevocable.
