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Renewal of bonus depreciation & enhanced expensing offers tax-saving opportunities

The recently enacted “Protecting Americans from Tax Hikes (PATH) Act of 2015” (P.L. 114-113, 12/18/2015) made a number of significant taxpayer-friendly changes in the tax law, but few have a wider impact on ordinary businesses than the retroactive permanent extension of the enhanced Code Sec. 179 expensing rules and the 5-year extension of 50% bonus first-year depreciation (with a rate that gradually decreases).

Enhanced Sec. 179 expensing. Under Code Sec. 179, a taxpayer, other than an estate, a trust, or certain noncorporate lessors, may elect to deduct as an expense, rather than to depreciate, up to a specified amount of the cost of new or used tangible personal property or certain real property placed in service during the tax year in the taxpayer’s trade or business. The maximum annual expensing amount generally is reduced dollar-for-dollar by the amount of Code Sec. 179 property placed in service during the tax year in excess of a specified investment ceiling. Amounts ineligible for expensing due to excess investments in expensing-eligible property can’t be carried forward and expensed in a subsequent year. Rather, they can only be recovered through depreciation. 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 succeeding tax years.

For tax years beginning in 2014: (1) the dollar limitation on the expensing deduction was $500,000; and (2) the investment-based reduction in the dollar limitation began to take effect when property placed in service in the tax year exceeds $2 million (the investment ceiling). Under the 2014 limits, the Code Sec. 179 deduction didn’t phase out completely until the cost of expensing-eligible property exceeded $2.5 million ($2 million (investment ceiling) + $500,000 (dollar limit)).

Under pre-Path Act law, for tax years beginning after Dec. 31, 2014, the maximum expensing limit dropped to $25,000, and the investment ceiling dropped to $200,000. Thus, the Code Sec. 179 deduction phased out completely when the cost of expensing-eligible property exceeded $225,000 ($200,000 (investment ceiling) + $25,000 (dollar limit)).

In general, under pre-PATH Act law, property was eligible for Code Sec. 179 expensing if it was:

…tangible property that’s Code Sec. 1245 property (generally, machinery and equipment), depreciated under the MACRS rules of Code Sec. 168, regardless of its depreciation recovery period;
…for any tax year beginning in 2010 through 2014, up to $250,000 of qualified real property—qualified leasehold improvement property, qualified restaurant property, and qualified retail improvement property that’s depreciable, acquired for use in the active conduct of a trade or business, and not otherwise excluded under Code Sec. 179. (Under a carryover limitation for qualifying real property no portion of the disallowed expensing could be carried to a tax year beginning after 2014); or
…depreciable computer software that is readily available for purchase by the general public, is subject to a non-exclusive license, and has not been substantially modified (i.e., off-the-shelf computer software), but only if placed in service in a tax year beginning before Jan. 1, 2015.

Under pre-PATH Act law, for tax years beginning before Jan. 1, 2015, an expensing election or specification of property to be expensed could be revoked without IRS’s consent, but, if revoked, couldn’t be reelected. However, for tax years beginning after Dec. 31, 2014, the expensing election, and any specification made in it, could be revoked only with IRS’s consent.

New law. The PATH Act made the following changes to the Code Sec. 179 expensing election:

  • The $500,000 expensing limitation and $2 million phase-out amounts are retroactively extended and made permanent. (Code Sec. 179(b))
  • For any tax year beginning after Dec. 31, 2015, both the $500,000 and $2 million limits are indexed for inflation. (Code Sec. 179(b)(6))
  • The rule that allows expensing for computer software is retroactively extended and made permanent. (Code Sec. 179(d)(1)(A)(ii))
  • For tax years beginning after Dec. 31, 2015, air conditioning and heating units are eligible for expensing. (Code Sec. 179(d)(1))
  • For tax years beginning after Dec. 31, 2014, an expensing election or specification of property to be expensed may be revoked without IRS’s consent. (Code Sec. 179(c)(2)) Thus, the ability to revoke a Code Sec. 179 election without IRS consent is made permanent.
  • Qualified real property is eligible to be expensed for tax years beginning before 2016 (Code Sec. 179(f)(1)), but no portion of disallowed expensing may be carried to a tax year beginning after Dec. 31, 2015. (Code Sec. 179(f)(4)) For tax years beginning after Dec. 31, 2015, expensing of qualified real property is made permanent without a carryover limitation (Code Sec. 179(f)(1), Code Sec. 179(f)(4) ), and the $250,000 expensing limitation with respect to qualifying real property is eliminated. (Code Sec. 179(f))

Interaction with de minimis safe harbor. The expensing break is enhanced by the de minimis safe harbor in the capitalization regs that allows businesses to elect to expense their outlays for “lower-cost” business assets. Under this safe harbor, which applies to an amount paid during the tax year to acquire or produce a unit of property, or acquire a material or supply, and which generally applies to amounts paid in tax years beginning on or after Jan. 1, 2014, qualifying businesses with an applicable financial statement (AFS) can expense eligible property if the amount paid doesn’t exceed $5,000 per invoice (or per item as substantiated by the invoice). If the taxpayer does not have an AFS, the same rule applies except that the amount paid for eligible property can’t exceed $2,500 per invoice (or per item as substantiated by the invoice).

Before 2016, the $2,500 amount was $500, but IRS won’t challenge an earlier use of the higher amount. The $5,000 and $2,500/$500 amounts can be changed by published IRS guidance. Assets expensed under the de minimis safe harbor election may be deducted in the year of purchase, assuming that the costs that otherwise qualify as ordinary expenses, and assuming the costs don’t have to be capitalized under the uniform capitalization (UNICAP) rules of Code Sec. 263A.

RIA observation: Under Code Sec. 179(d)(1)(A)(i), “section 179 property” generally is any tangible property to which Code Sec. 168 applies. Thus, assets to which the de minimis election applies (and which aren’t capitalized and depreciated) should not be counted in determining either the Code Sec. 179 maximum expensing limit or the investment ceiling.
RIA illustration Large Corp, a calendar year corporation that has an AFS, has a written accounting policy at the beginning of 2015, which it follows, to expense amounts paid for property costing $5,000 or less. In 2015, it pays $750,000 to buy 500 computers at $1,500 each, and $250,000 to buy 50 high-speed network printers at $5,000 each. Each computer and printer is a unit of property, and the amounts paid for them meet the requirements for the de minimis safe harbor. During 2015, Large Corp also spends a total of $1 million on other equipment and business assets that are not eligible for the de minimis safe harbor and instead must be capitalized. Large Corp, which isn’t subject to the UNICAP rules of Code Sec. 263A, elects to apply Reg. § 1.263A-1(f) (i.e., the de minimis safe harbor rule) to amounts paid in tax years beginning on or after Jan. 1, 2014. Under the final regs, Large Corp should be able to deduct $1.5 million of the total cost of its machinery and equipment purchases during 2015 ($1 million under the de minimis safe harbor, and $500,000 under the Code Sec. 179 expensing election).

Related expensing changes. The PATH Act also provided that:

…the expensing rules for qualified film and television productions are retroactively restored and extended to productions beginning before Jan. 1, 2017. (Code Sec. 181(g)) In addition, for production that begin in calendar year 2016, they apply to qualified live theatrical productions (Code Sec. 181(a); Code Sec. 181(g));
…the election to expense the cost of qualified advanced mine safety equipment property is retroactively restored and extended to property placed in service through 2016; (Code Sec. 179E(g)) and
…the special Code Sec. 179 expensing election for enterprise zone businesses (increasing the maximum amount that can be expensed by $35,000 and computing the phaseout of the maximum amount allowed to be expensed using 50% of the cost of the qualified zone property) is retroactively restored and extended through Dec. 31, 2016. (Code Sec. 1397A(a)(12),Code Sec. 1391(d)(1)(A))

Bonus first-year depreciation. Under pre-PATH Act law, Code Sec. 168(k) generally allowed an additional first-year depreciation deduction (also called bonus first-year depreciation) equal to 50% of the adjusted basis of qualified property acquired and placed in service after Dec. 31, 2011, and before Jan. 1, 2015 (before Jan. 1, 2016 for certain longer-lived and transportation property). The additional first-year depreciation deduction was allowed for both regular tax and alternative minimum tax (AMT) purposes, but was not allowed for purposes of computing earnings and profits. The basis of the property and the depreciation allowances in the year of purchase and later years were appropriately adjusted to reflect the additional first-year depreciation deduction. A taxpayer could elect out of additional first-year depreciation for any class of property for any tax year.

In general, an asset qualified for the bonus depreciation allowance if:

…It fell into one of the following categories: property to which the modified accelerated cost recovery system (MACRS) rules apply with a recovery period of 20 years or less; computer software other than computer software covered by Code Sec. 197; qualified leasehold improvement property; or certain water utility property.
…It was placed in service before Jan. 1, 2015. (Certain long-production-period property and certain transportation property could be placed in service before Jan. 1, 2016.)
…Its original use commenced with the taxpayer. Original use was the first use to which the property is put, whether or not that use corresponded to the taxpayer’s use of the property.

New law. The PATH Act extended bonus depreciation for qualified property acquired and placed in service during 2015 through 2019 (subject to a phase down), through 2020 for certain longer-lived and transportation property. Eligible taxpayers will be able to claim:

1. a 50% bonus depreciation allowance for qualified property placed in service in 2015 through 2017;
2. a 40% bonus depreciation allowance for qualified property placed in service in 2018; and
3. a 30% bonus depreciation allowance for qualified property placed in service in 2019. (Code Sec. 168(k))

The percentages apply to certain longer-lived and transportation property placed in service one year later than shown in the list above.

RIA recommendation: The above changes, which were enacted late in 2015, are retroactive. Thus, a fiscal year taxpayer that, for its tax year ending in calendar year 2015 (the 2015 year), could benefit from the bonus depreciation, but filed its 2015 tax year return before the retroactive extension of bonus depreciation, may want to consider filing an amended return.

Related bonus depreciation changes. The PATH Act also provided that:

  • For property placed in service after Dec. 31, 2014 and before Jan. 1, 2020, the Code Sec. 280F limitation for passenger autos and for light trucks or vans (i.e., passenger autos built on a truck chassis, including minivans and sport-utility vehicles (SUVs) built on a truck chassis, rated at 6,000 pounds gross (loaded) vehicle weight or less) is increased (subject to a phase down) for qualified property subject to bonus depreciation. For an auto or light truck or van placed in service in 2015 through 2017, the limitation is increased by $8,000; for an auto or light truck or van placed in service in 2018, the limitation is increased by $6,400; and for an auto or light truck or van placed in service in 2019, the Code Sec. 280F limitation is increased by $4,800. (Code Sec. 168(k)(2))
  • For property placed in service after Dec. 31, 2014, the 15-year recovery period for qualified leasehold improvement property, qualified restaurant property, and qualified retail improvement property is retroactively restored and made permanent. (Code Sec. 168(e)(3)(E)) For property placed in service after Dec. 31, 2015, qualified leasehold improvement property is no longer qualified property, but instead a new category, “qualified improvement property” (which includes qualified leasehold improvement property and qualified retail improvement property) is qualified property (eligible for bonus depreciation); qualified restaurant property may or may not meet the requirements for qualified improvement property. First-year bonus depreciation is allowed for qualified improvement property without regard to whether the improvements are property subject to a lease, and there is no requirement that the improvement must be placed in service more than three years after the date the building was first placed in service. (Code Sec. 168(k)(3))
  • For plants planted or grafted after Dec. 31, 2015 and before Jan. 1, 2020, bonus depreciation (subject to a phase down) is allowed for certain trees, vines, and plants bearing fruit or nuts when planted or grafted, rather than when placed in service; 50% for a plant that is planted or grafted in 2016 or 2017; 40% for a plant that is planted or grafted in 2018; and 30% for a plant that is planted or grafted in 2019. (Code Sec. 168(k)(5))
  • For tax years beginning after Dec. 31, 2014 and before Jan. 1, 2020, the elective exchange by corporations trading bonus and accelerated depreciation for the refund of otherwise deferred AMT credits is retroactively restored and extended (subject to a phaseout). (Code Sec. 168(k)(4))
  • The special rule for the allocation of bonus depreciation to a long-term contract is extended for five years to property placed in service before Jan. 1, 2020 (Jan. 1, 2021, in the case of certain longer-lived and transportation property). (Code Sec. 460(c)(6)(B))
  • For property placed in service after Dec. 31, 2014 and before Jan. 1, 2017, first-year 50% bonus depreciation allowance for second generation biofuel plant property is retroactively restored and extended. (Code Sec. 168(l)(2)(D)))

Planning considerations. Under Code Sec. 179 expensing, the most accelerated form of depreciation available, an eligible taxpayer can elect to deduct all or part of the cost of qualifying property (Code Sec. 179 property) in the tax year the qualifying property is placed in service, even if the property is placed in service on the last day of the year. However, as noted above, besides not being available to certain taxpayers (e.g., estates and trusts, and many non-corporate lessors), a number of other limitations apply. And, the expensing deduction is limited by an annual maximum dollar amount and an investment ceiling that gradually reduces the deduction if more than a specified amount of qualifying property is placed in service by the taxpayer during the tax year. The expensing deduction is further limited to taxable income from the taxpayer’s active trades or businesses, with any amount which can’t be deducted because of this limitation carried over indefinitely to later years. The property subject to expensing must be purchased for use in the active conduct of a trade or business, not merely for the production of income.

On the other hand, bonus depreciation, while not providing as quick or as large a deduction as Code Sec. 179 expensing, is not subject to an active business income requirement, maximum amount limitation, or a deduction phaseout for amounts in excess of a specified investment ceiling. Bonus depreciation is available only for property whose original use begins with the taxpayer, but the property can not only be used in a trade or business, it can also be used for the production of income. However, while the 50% bonus depreciation portion isn’t subject to the depreciation conventions (half-year and mid-quarter conventions which reduce the depreciation deduction based on when in the tax year the property is treated as placed in service), the conventions do apply to the other first-year depreciation deductions allowed with respect to qualified property.

In many cases, a taxpayer may be able to use both methods.

RIA illustration On June 1, 2015, Smallco, a calendar-year taxpayer, bought 5-year MACRS property for $526,000 and immediately placed it in service. The property qualifies for bonus depreciation and Code Sec. 179 expensing. Smallco didn’t buy any other property eligible for the Code Sec. 179 election in 2015. Smallco makes the Code Sec. 179 election and depreciates the remaining property using the accelerated 200% declining balance method of depreciation; a 5-year recovery period; the half-year convention; and the optional depreciation tables.For 2015, Smallco is allowed a $500,000 deduction under Code Sec. 179. Smallco reduces the $526,000 cost by the $500,000 Code Sec. 179 deduction, resulting in an unadjusted depreciable basis of $26,000, which yields a 50% bonus depreciation deduction of $13,000 ($26,000 × 50%). Smallco has an unadjusted depreciable basis of $26,000 (which is reduced by $13,000 bonus depreciation) resulting in a remaining adjusted depreciable basis of $13,000 and an allowable depreciation deduction in 2015 of $2,600 for the first year ($13,000 × 20%, the annual depreciation rate from the optional depreciation tables). Thus, Smallco’s total deduction for 2015 on property costing $526,000 is $515,600.