First-Year Depreciation Incentives Are Ending Soon


As we all know, the recession caused Congress to dramatically increase tax incentives for businesses that expend amounts for capital equipment and certain building improvements. Congress expanded the long-standing Section 179 deduction to the point that it is currently at $500,000 per year. Similarly, Congress added an incentive in the form of 100% bonus depreciation for many new (rather than used) asset additions.

Congress extended these provisions into 2012, but did so at reduced amounts. With the economy gradually recovering and the budget pressures greater than ever, our expectation is that these 2012 limits signal the end of the large first-year deductions.

Overview of Bonus Depreciation

From 2008 through most of 2010, the bonus depreciation deduction was 50% of the cost of new assets. For assets acquired and placed in service from 9/9/10 through 12/31/11, the deduction moves up to 100%. Congress has also extended the deduction into 2012, but at a lower 50% rate. Presently, the tax law does not extend bonus depreciation after 12/31/12, and it appears that any extension is unlikely.

To qualify for either 100% or 50% bonus depreciation, the asset must have its original use commence with the taxpayer (i.e., it is new rather than used property), and must have a depreciable life of 20 years or less. Virtually all tangible personal property (such as autos, trucks, machinery, and equipment) has a depreciable recovery period of 20 years or less, and accordingly all are eligible.

Overview of Section 179 Deduction

For most of the past decade, the Section 179 deduction was maximized at just over $100,000. When the recession hit, Congress bumped the limit to $250,000, but later increased the amount to $500,000 for tax years beginning in 2010 and 2011. More recently, Congress indicated that for tax years beginning in 2012, the Section 179 deduction would drop back to a $125,000 (although inflation indexing is applied, and the actual number should be $130,000–$135,000).

Not only will the Section 179 deduction shrink beginning in 2012, but fewer small businesses will have access to this write-off. During 2011, the deduction phases-out only if a taxpayer’s eligible Section 179 asset purchases exceed $2 million. Starting in 2012, the phase-out threshold is $500,000 of asset additions.

The Section 179 deduction applies to both new and used asset additions. It applies to machinery and equipment, software, and, for 2011 only, up to $250,000 of qualified real property improvements. Qualified real property improvements include improvements to restaurant buildings and interiors of retail and leased nonresidential buildings. Farmers can also claim the Section 179 deduction on special use or single purpose ag buildings such as bins, drying systems, and livestock barns. However, it is not available for general purpose ag buildings such as machine sheds and shops, nor is it generally available to landlords who purchase or construct assets that are used by a tenant.

Quick Reference Chart

The following chart is a summary of the first-year depreciation incentives that are in the law through 2012, as well as the amounts that we expect to be applicable for 2013 and after. The latest legislation from Congress for 2012 seems to signal that these incentives are ending, and that the new norm for the Section 179 deduction would be $125,000, although adjusted upward for annual inflation indexing.

Here is the summary chart:

                              First-Year Depreciation Incentives
 

Calendar

 

Section 179

 

Bonus

 
 

Year

 

Limit (1, 2, 3)

 

Depreciation (4 ,5) 

 
 

      2011

 

$500,000

 

100%

 
 

     2012

 

   125,000

 

50%

 
 

2013 (estimated)

 

  125,000

 

0%

 

1-Fiscal year taxpayers apply the Section 179 limit for the tax year beginning in 2011, 2012, or 2013.

2-The 2012 (and estimated 2013) Section 179 limits are inflation-indexed by reference to 2006.

3-Both new and used asset additions qualify.

4-The asset must have its original use commence with the taxpayer (i.e. only new assets qualify).

5-All taxpayers, regardless of whether reporting on a calendar or fiscal tax year, apply the bonus depreciation % based on which calendar year the asset was acquired and placed in service.

If you are planning on taking advantage of major purchases or improvements while these large allowances are still in the tax law, we recommend that you have a detailed depreciation projection prepared. These depreciation incentives can shelter a significant amount of income, but the eligibility rules can be tricky and it’s important to have an accurate expectation of the deductions that will be coming your way.

 
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About Don James, CPA/PFS, CFP
Don is the Tax & Financial Planning partner with Kiplinger & Co., CPAs headquartered in sunny Cleveland, Ohio since 1982. He partners with business owners and families and specializes in goal achievement solutions, tax minimization strategies and serves in the role of gatekeeper of sound financial advice.

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