Combine Deductions For a Real Tax-Saving Windfall

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March 06, 2008

On February 13, President Bush signed the Economic Stimulus Act of 2008, which contains the valuable rebates for individual taxpayers. In addition, the new law includes two significant business tax breaks in the form of bigger depreciation write-offs:

  1. Bigger Section 179 depreciation deductions are allowed for qualifying assets placed in service in tax years beginning in 2008. Under the Section 179 deduction privilege, many small and medium-sized businesses can instantly depreciate most or all of the cost of qualifying new and used assets in the year they are first placed in service.
  2. First-year bonus depreciation of an extra 50 percent is allowed for certain assets.

Now for the details about the deduction amounts that can be claimed this year, the businesses that are eligible for the tax breaks, and the types of assets that qualify.

Section 179 Deduction Goes Up for One Year Only

The Economic Stimulus Act almost doubles the maximum Section 179 deduction, but only for the 2008 tax year when the maximum write-off is generally increased to a whopping $250,000 (up from $128,000 before the new law). For 2009 to 2010, the maximum deduction will revert to $125,000 (plus inflation adjustments) unless Congress takes further action.

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Under a phaseout rule, a business that buys a great deal of assets that would otherwise qualify for Section 179 deductions can lose part or all of its write-off. Specifically, the maximum Section 179 deduction for an affected business is reduced dollar for dollar by the amount of qualifying assets in excess of a threshold for the year. For tax years beginning in 2008, the phaseout threshold is generally increased to a whopping $800,000 (up from $510,000 before the new law).

The higher threshold means that many more medium-sized businesses will be eligible for Section 179 deductions for tax years beginning in 2008. For 2009 to 2010, however, the phaseout threshold will revert to only $500,000 (plus inflation adjustments) unless Congress acts to extend the higher amount.

Example 1: Let's say a small business adds $200,000 worth of new and used equipment and software during its 2008 tax year. Under the expanded Section 179 deduction break, the company can write off the entire $200,000 on its 2008 business tax return, as long as the business still has positive taxable income after subtracting the Section 179 deduction. Before the new law, the company's Section 179 deduction would have been limited to only $128,000.

Example 2: A medium-sized corporation adds $825,000 worth of new and used equipment and software during its 2008 tax year. Under the liberalized Section 179 deduction rules for 2008, the company can write off $225,000 on this year's tax return ($250,000 maximum Section 179 deduction reduced by the $25,000 excess over the $800,000 phaseout threshold). Before the new law, the business would have been ineligible for any Section 179 deduction due to the phaseout rule.

First-Year Bonus Depreciation Is Back

You may remember 50 percent first-year bonus deprecation, a valuable deduction that expired a few years ago. Thanks to the new law, it's back for a return engagement - but only for certain assets.

Under first-year bonus depreciation, your business can immediately deduct half of the cost of a new asset if it is purchased and placed in service during calendar 2008. Then, you can write off the remaining cost with the Section 179 deduction (if available) and/or regular depreciation deductions over the asset's designated recovery period.

As you can see, the new law creates a real tax-saving windfall for small and medium-sized businesses that can take advantage of both the expanded Section 179 deduction privilege and 50 percent first-year bonus depreciation. Reason: They can combine these two breaks to offset a big chunk, or maybe all, of their taxable income for the year.

Needless to say, there are some ground rules. To be eligible for 50 percent first-year bonus depreciation, an asset must meet these three requirements:

Requirement 1: Be qualified property (including qualified leasehold improvement property), which is defined below.

Requirement 2: Be purchased new during calendar year 2008. Used assets do not qualify.

Requirement 3: Be placed in service by December 31, 2008, or by December 31, 2009 for certain long-lived assets (explained below).

What Types of Assets Qualify?

To be qualified property, an asset must fit one of the following descriptions:

  • Property with a depreciation recovery period of 20 years or less. This category includes most types of tangible personal property used for business.
  • Depreciable computer software that is not amortizable over 15 years. Since the 15-year rule rarely applies, most purchased software is eligible for 50 percent first year bonus depreciation.
  • Qualified leasehold improvement property (explained below).
  • Water utility property. This is an arcane asset category. You know it if you have it.

Only New Assets With One Exception

An asset is eligible for the 50 percent first-year bonus depreciation break only if its original use commences with the taxpayer after December 31, 2007. In other words, the asset must be new rather than used. A special exception applies to assets that are sold by a taxpayer and then leased back to the same taxpayer.

Leasehold Improvement Costs Can Qualify Too

The 50 percent first-year bonus depreciation privilege is available for the cost of qualified leasehold improvement property. To meet this definition, all of the following tests must be passed.

  • The improvement must be made to the interior portion of a building.
  • The building must be nonresidential real property.
  • The improvement must be made pursuant to, or under, a lease by either the party leasing (or sub-leasing) or the landlord of the property, which will be occupied exclusively by the lessee (or sub-lessee).
  • The improvement must be made more than three years after the date the building was first placed in service.

Extended Deadline for Long-Lived Assets
The placed-in-service deadline for qualifying property with longer lives is extended to December 31, 2009(compared to the general December 31, 2008 deadline) for the following types of assets:

  • Qualifying property with a depreciation recovery period of 10 years or longer.
  • Certain transportation equipment.
  • Certain aircraft.

Key Point: With an extended placed-in-service deadline, only the portion of cost that is allocable to calendar year 2008 is eligible for 50 percent first-year bonus depreciation. Costs allocable to other periods must be depreciated under the normal guidelines.

Bigger First-Year Write-offs for New Cars and Light Trucks

For a new passenger auto or light truck that is used more than 50 percent for business and is subject to the unfavorable luxury auto depreciation limitations, the bonus depreciation tax break increases the maximum first-year depreciation deduction by a hefty $8,000. Used vehicles do not qualify.

So for a new car purchased and placed in service in 2008, the maximum first-year depreciation deduction is $11,060 thanks to the Economic Stimulus Act. The amount is $11,160 for a new light truck purchased and placed in service in 2008.

Key Point: The full $11,060 or $11,160 amount is only available when the new car or light truck is used 100 percent for business. For instance, say you use a new passenger auto 75 percent for business. Your maximum first-year write-off is reduced to $8,295 (75 percent times $11,060).

Bonus Depreciation Means Better Deductions for Heavy SUVs Too

As you may know, the maximum Section 179 deduction for a heavy SUV is $25,000.
Congress keeps talking about completely eliminating the deduction for these gas guzzling vehicles, but it hasn't happened yet. In fact, the 50 percent first-year bonus depreciation break can be combined with the $25,000 Section 179 deduction to make heavy SUVs into really great tax-saving machines.

Example 3: Let's say a small business uses the calendar year for tax purposes. During 2008, the owner buys a new $65,000 Cadillac Escalade and uses it 80 percent for business. So the depreciable cost of the vehicle is $52,000 (80 percent times $65,000). On the owner's 2008 business tax return, a $25,000 Section 179 deduction can be claimed. Then, the business can write off another $13,500 under the 50 percent first-year bonus depreciation rule ($52,000 minus $25,000 equals $27,000 times 50 percent equals $13,500). Finally, the business can generally write off another $2,700 under the normal depreciation rules ($52,000 minus $25,000 minus $13,500 equals $13,500 times 20 percent equals $2,700). When all is said and done, the first-year depreciation deductions add up to $41,200, which is an astonishing 79 percent of the business portion of the vehicle's cost!

Key Point: To qualify for the Section 179 deduction and 50 percent first-year bonus depreciation, you must use the SUV more than 50 percent for business, it must be new, and it must have a gross vehicle weight rating (GVWR) of more than 6,000 pounds. You can usually find the GVWR on an imprinted label inside the driver's door where the hinges meet the frame.

(For more information about the rebates in the new Economic Stimulus Act, click here to read our article, "A Gift of Cash for Individuals.")

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