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Businesses Receive Temporary Depreciation Bonus

With the enactment of the Job Creation and Workers Assistance Act of 2000, small businesses buying new property may now take a generous, upfront thirty-percent (30%) depreciation bonus.  The offer is available only for a limited time, many states are not allowing the bonus, and some businesses may come out better from a tax standpoint by not taking the offer at all.

What property is covered by this bonus? Generally, property with a class life of less than 20 years will be considered relevant.  Everyday examples include certain computer software, qualified leasehold improvement property and water utility property.  The largest determinant is that the property must be new.  Only funds used to recondition or rebuild property can bypass this clause.[Journal of Financial Planning, August 2002]

An example of how this deduction works is as follows:  For instance, a business spends $200,000 on machinery with a seven-year depreciable life basis.  The first-year standard depreciation by itself would be $28,580.  The thirty-percent (30%) bonus depreciation would be $60,000.  Because the thirty-percent (30%) bonus is calculated first, and the standard depreciation rate is calculated on the remaining seventy-percent (70%), the total first-year write-off is an astounding $80,006!

A business can also parlay the thirty-percent (30%) bonus depreciation with the Section 179 expense deduction, for which the maximum in 2002 is $24,000 ($25,000 in 2003).  The $24,000 is taken off the top first, then the thirty-percent (30%) bonus is calculated on the remaining amount.  The standard depreciation amount is calculated on the leftovers.  In this example, including the full Section 179 expense, the total first-year write-off is $94,405—nearly half of the total cost of the equipment.

The law also throws in a special bonus depreciation for “luxury” vehicles.  “Luxury” in this sense is defined as any non-electric car, light truck or minivan used for business that costs more than $15,300.  Businesses could take a maximum $3,060 deduction for these vehicles in 2002.  Under the bonus depreciation, businesses can take an additional maximum of $4,600, for a total first year deduction of $7,660.  Some large passenger vehicles (mostly SUVs) escape these “luxury” auto rules and are entitled to the thirty-percent (30%) bonus depreciation regardless.

For the thirty-percent (30%) bonus and the vehicle deduction, the property must have been purchased after September 10, 2001, and before September 11, 2004.  Additionally, it must be placed into service no later than December 31, 2004.

To make sure the Alternative Minimum Tax (AMT) does not negate some of these benefits, Congress allows the bonus deduction for purposes of computing AMT.  However, states have yet to catch the generosity bug.  Some states simply do not allow the new bonus and others are taking steps to disallow it.

The intent of the federal bonus is to stimulate business investment.  However, keep in mind that though accelerating depreciation with the bonus frees up more cash in the first year for the business owner, it does not reduce the overall amount that owners can depreciate.  That total is still limited to the adjusted cost basis.

As previously mentioned, some businesses may find it more advantageous from a tax perspective to not take the bonus.  This might include businesses with net-operating loss carryovers about to expire, or those who anticipate a higher tax bracket in future years.  But usually it is more advantageous to save taxes today rather than tomorrow, so the numbers will need to be evaluated to see if it is really worth it to elect out.

A business must specifically “elect out” of the bonus depreciation, if that is the strategy chosen.  If the election is made, then the decision applies to all property for that year with that particular election schedule, such as all five-year property or all seven-year property.

Busineses who bought qualifying property in 2001 (after September 10), but who were unable to take the deduction on their 2001 returns, may want to consider filing amended returns.  The IRS recently issued guidelines on how to recoup missed bonus depreciation on 2001 returns.

For Further information on how businesses can receive a temporary depreciation bonus contact James J. Holtzman, CPA at (412) 635-9210 Extension 19.

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