For most taxpayers, bonus first-year depreciation ends Dec. 31, 2004.
This means that taxpayers who want to maximize their depreciation deductions for 2004 should accelerate purchases of new depreciable assets into this year.
Taxpayers are entitled to a bonus first-year depreciation allowance equal to 50 percent of the unadjusted depreciable basis of property if all of the following requirements are met:
* The property must be modified accelerated cost recovery system property with a recovery period of 20 years or less; or computer software (but not computer software amortized under Internal Revenue Code Section § 197); or qualified leasehold improvement property; or water utility property.
* The original use of the property must begin with the taxpayer after May 5, 2003. Original use is the first use to which the property is put, whether or not that use is the same as the use of the property by the taxpayer.
* The property must be acquired by the taxpayer after May 5, 2003, and before Jan. 1, 2005, but only if no written binding contract for the acquisition was in effect before May 6, 2003.
* The property must be placed in service by the taxpayer before Jan. 1, 2005. However, certain specialized classes of long-life property (property with a recovery period of at least 10 years and certain property used to transport persons and property) are eligible for 50 percent bonus depreciation if placed in service before Jan. 1, 2006, but only to the extent that the adjusted basis is attributable to manufacture, construction or production before Jan. 1, 2005.
A taxpayer may elect to claim bonus first-year depreciation at a 30 percent rate (instead of the 50 percent rate) or elect not to claim bonus first-year depreciation at all.
Bonus depreciation and expensing
Bonus first-year depreciation is especially valuable to businesses that will make maximum use of IRC § 179 expensing, or that won't be able to use it at all because of large purchases of expensing-eligible assets. For tax years beginning in 2004, the maximum expensing allowance of $102,000 is phased out dollar-for-dollar by the amount of expensing-eligible assets placed in service in excess of $410,000, and is unavailable when investment in expensing-eligible assets attains $512,000.
Late-year tax planning
The bonus depreciation deduction is not prorated for the time that qualifying property is in service in the year. This means that the full amount of bonus depreciation is available even if qualifying assets are in service for only a few days in 2004.
Example 1: Your client, a calendar-year C corporation, is considering buying and placing in service five-year MACRS property in the last quarter of 2004. It would not be eligible to expense any part of any property that it buys. Even if it does not make the purchase until the end of December 2004, it will be eligible for the 50 percent bonus depreciation as long as the property is placed in service before the end of 2004.
Suppose your client buys $200,000 of MACRS property on Dec. 23, 2004, that it places in service on Dec. 29, 2004. If the mid-quarter convention applies, and your client depreciates the asset using the 200 percent declining balance method, your client will be able to claim a MACRS depreciation deduction of $105,000 for the property for 2004 ($100,000 bonus depreciation [50 percent of $200,000 cost] plus $5,000 of regular depreciation [5 percent (the mid-quarter convention rate for five-year MACRS property placed in service in the last quarter of the year) of $100,000 ($200,000 less bonus depreciation of $100,000)]).
This depreciation deduction of more than half the cost of the property is allowed, even though the property is in service for only a few days in 2004. If your client waits until 2005 to buy the property and place it in service, its first-year depreciation deduction (assuming the mid-quarter convention would also apply in 2005) would be only $70,000 (35 percent of $200,000).
Example 2: The same facts apply as in Example 1, except that the half-year convention applies. Your client would be able to deduct depreciation of $120,000 if it buys and places the $200,000 of five-year MACRS property in service in December of 2004. This equals bonus depreciation of $100,000 plus regular depreciation of $20,000 (20 percent [the half-year convention rate for five-year MACRS property placed in service at any time during the year] of $100,000). If your client waits until 2005 to buy the property and place it in service, its first-year depreciation deduction (assuming the half-year convention would also apply in 2005) would be only $40,000 (20 percent of $200,000).
Claiming expensing, too
If IRC § 179 expensing is claimed for part of the cost of an asset, the amount expensed is subtracted before the additional 50 percent first-year depreciation allowance is computed. The taxpayer then computes regular first-year depreciation (and depreciation for future years) with reference to the adjusted basis remaining after expensing and after the additional 50 percent first-year allowance.
Example 3: Your client, a C corporation with a fiscal year ending April 30, is considering buying new seven-year MACRS property toward the end of 2004 or the beginning of 2005. Assume that on Dec. 15, 2004, it buys $250,000 of seven-year MACRS property that it places in service on Dec. 22, 2004. Also assume that your client is eligible to expense, and elects to expense $70,000 of the cost of the property, and that the half-year MACRS depreciation convention applies for the placed-in-service year.
In addition to the $70,000 expensing deduction, your client can deduct $102,861 of depreciation with respect to the property in its fiscal year ending April 30, 2005. This amount equals bonus depreciation of $90,000 (50 percent of $180,000 [$250,000 cost less $70,000 expense deduction]) plus $12,861 (14.29 percent [the half-year convention rate for seven-year MACRS property] of $90,000 [the remaining basis in the property after deducting the bonus depreciation of $90,000 and the expense deduction of $70,000]). The total deduction allowed for the property in the fiscal year that it is placed in service is $172,861 (expense deduction of $70,000 plus depreciation of $102,861).
Eligibility of MACRS property
Assume that otherwise eligible MACRS property or computer software is acquired in a like-kind exchange under IRC § 1031 or as a result of an involuntary conversion under IRC § 1033. If either occurs, both the carry-over basis and the excess basis, if any, of the acquired property are eligible for bonus depreciation (Reg. § 1.168(k)-1T(f)(5)(iii)(A)). The regulations make it clear that it is possible for an initial expenditure on a qualifying asset to result in two bonus depreciation allowances.
Example 4: On Nov. 15, 2003, your client, a calendar-year C corporation, bought and placed in service a new computer for which it paid $20,000. Your client depreciated the computer using the 200 percent declining balance method and the half-year convention over the five-year MACRS recovery period. In 2003, your client claimed 50 percent bonus first-year depreciation of $10,000 for the computer (50 percent of the cost of $20,000), and regular MACRS depreciation of $2,000 (20 percent of $10,000 [$20,000 cost less $10,000 of bonus depreciation]). Total depreciation of $12,000 with respect to the computer was claimed in 2003, leaving an adjusted basis of $8,000 at the start of 2004.
On Dec. 15, 2004, your client acquired a new computer by exchanging the computer it bought in 2003 and $8,000 cash in a like-kind exchange. The following results apply under Reg. § 1.168(i)-6T (unless your client elects not to apply the temporary regulations for depreciating property acquired in a like-kind exchange or as the result of an involuntary conversion):
* For 2004, your client may claim a regular MACRS depreciation deduction of $1,600 for the original computer (16 percent [one-half of the 32 percent rate normally used for five-year MACRS property in the second year of use, since the property was disposed of that year] of $10,000 [original cost of $20,000 less bonus depreciation of $10,000]).
* For 2004, the 50 percent bonus first-year depreciation deduction for the new supercomputer is $7,200. This equals the sum of $3,200 (50 percent of the carry-over basis of the original computer of $6,400 [adjusted basis of $8,000 at the beginning of 2004 less $1,600 of depreciation taken in 2004]), plus $4,000 (50 percent of the $8,000 cash paid in the like-kind exchange).
In effect, your client's investment of $20,000 for the original computer in 2003 resulted in 50 percent bonus depreciation of $10,000 in 2003, and $3,200 of bonus depreciation in 2004.
Bob Rywick is an executive editor at RIA, in New York, and an estate planning attorney.
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