Fixed-Asset Implications Under the American Taxpayer Relief Act of 2012

Editor: Kevin D. Anderson, CPA, J.D.

Expenses & Deductions

While much of the attention of the recent fiscal cliff debate was focused on the increased income tax rates for high-income individuals, there are many provisions in the new legislation that are favorable to businesses, particularly in the fixed-asset area. The American Taxpayer Relief Act of 2012 (ATRA), P.L. 112-240, which was signed on Jan. 2, 2013, provides many incentives for businesses to expand and purchase assets, including the extension of bonus depreciation, Sec. 179 small business expensing, and shortened tax depreciation lives for qualifying properties.

50% Bonus Depreciation Extended for One Year

Normally the cost of a capital asset is recoverable over the life of the asset. To encourage investment, Congress enacted bonus depreciation provisions that have allowed taxpayers to accelerate recovery of the costs of purchasing certain assets. The bonus deprecation amounts have varied from 30% to 100%, with the most recent first-year depreciation deduction being 50%. This favorable bonus depreciation provision was set to expire on Dec. 31, 2012. ATRA extended the 50% first-year bonus depreciation to qualified property acquired and placed in service before Jan. 1, 2014, and certain longer period production and transportation properties are eligible for 50% bonus depreciation through 2014 (Sec. 168(k)(2), as amended by ATRA Section 331(a)).

Bonus depreciation is available only for new property with respect to which the original use commences with the taxpayer. In addition, it must be property depreciated under the modified accelerated cost recovery system (MACRS) that has a recovery period of 20 years or less, water utility property, computer software depreciable over three years under Sec. 167(f), or qualified leasehold improvement property. It also includes certain property with a long production period as defined in Sec. 168(k)(2)(B). A taxpayer may elect out of the additional first-year depreciation for any class of property for any tax year. Also, the choice under Sec. 168(k)(4) to forgo bonus depreciation in exchange for an increase in the alternative minimum tax credit limitation was likewise extended.

The extension of bonus depreciation in ATRA is also beneficial for taxpayers purchasing a new vehicle. The “luxury auto” rules severely limit the amount of depreciation that can be taken on many vehicles. Under Sec. 280F, depreciation deductions that can be claimed for passenger autos are subject to dollar limits that are adjusted annually for inflation. For passenger automobiles, the adjusted first-year limit in 2013 is $3,160 ($3,360 for qualifying light trucks or vans). If bonus depreciation is claimed, the amount that can be deducted is increased by $8,000. Therefore, if bonus depreciation is claimed on a passenger car in 2013, the allowable deduction is $11,160 ($11,360 for qualifying light trucks or vans).

Favorable Recovery Periods for Qualified Property

ATRA extended some of the shorter write-off periods and accelerated deductions for certain types of property. These industry-specific provisions include, among others, special treatment for motorsports entertainment complexes, business property on Indian reservations, qualified restaurant buildings and improvements, qualified retail improvements, and qualified leasehold improvements.

ATRA retroactively extends for two years, through 2013, a short seven-year cost recovery period for motorsports entertainment complexes under Sec. 168(i)(15). A motorsports entertainment complex is defined as a racing track facility situated permanently on land that hosts one or more racing events for automobiles, trucks, or motorcycles during a 36-month period following the first day of the month in which the facility is placed in service. The events also must be open to the public for the price of admission (Sec. 168(i)(15)).

ATRA also extends the special depreciation recovery periods for qualified Indian reservation property under Sec. 168(j). Generally, to qualify this property must be used predominantly in the active conduct of a trade or business within an Indian reservation, which is not used outside the reservation on a regular basis and was not acquired from a related person. These shortened recovery periods, provided in a special table, are in lieu of the generally applicable recovery periods set forth in Sec. 168(c), and no alternative minimum depreciation adjustments are required if the shorter recovery periods are used. The provision retroactively applies to property placed in service after Dec. 31, 2011, and before Jan. 1, 2014.

Last, the 15-year straight-line cost-recovery write-off for qualified leasehold improvements, qualified retail improvements, and qualified restaurant buildings and improvements was reinstated and extended (Secs. 168(e)(3)(E) and (e)(8)(E)). This applies retroactively for two years, through 2013, and therefore applies to property placed in service after Dec. 31, 2011, and before Jan. 1, 2014.

The American Jobs Creation Act of 2004, P.L. 108-357, created the 15-year property category called “qualified restaurant property.” This property includes a building, or an improvement to a building, if more than half of its square footage is devoted to preparing and serving meals. For example, a small cafeteria in a bookstore will likely not qualify based on the square footage requirement. Qualified restaurant property can include a new building; this definition is more expansive than the requirements for retail and leasehold property.

“Qualified retail improvement property” was first created as a MACRS property category in the Emergency Economic Stabilization Act of 2008, P.L. 110-343. This property includes improvements made to the interior of a building more than three years after the building is placed in service that is used as a retail store open to the general public. Last, qualified leasehold improvement property is generally defined as Sec. 1250 leasehold improvements made to a commercial property by a lessor or a lessee under a lease more than three years after the commercial property was placed in service (Sec. 168(e)(6)). Retroactively extending these three 15-year straight-line cost recovery provisions will result in favorable accelerated depreciation deductions. But for the extension of these provisions, the property would be treated as nonresidential real property and be depreciable over 39 years using the midmonth convention.

Small Business Expensing: Sec. 179 Expense

Sec. 179 allows businesses to write off some or all of the acquisition costs of qualifying properties, as opposed to depreciating them over the life of the asset. The annual limitation was $500,000 in 2011 but dropped to $125,000 in 2012. It was expected to drop to $25,000 in 2013. While this amount is the maximum amount that can be expensed, the annual dollar amount is reduced dollar for dollar by the amount that the taxpayer’s total investment exceeds the annual investment limits. This annual investment limit likewise has been decreasing. The amount was $2 million in 2011 and $500,000 in 2012, and it was expected to drop to $200,000 in 2013.

There were concerns that these reductions would hinder the desire for small businesses to invest and further depress economic recovery. As a result, ATRA retroactively reinstated the $500,000 limit for 2012 and continued this limit for 2013. In addition, the $2 million annual investment limit was retroactively reinstated for 2012 and prospectively continued for 2013. ATRA also extended the rule allowing taxpayers to expense off-the-shelf computer software under Sec. 179. The retroactive extension of the annual limitation and investment limit may provide planning opportunities for an immediate write-off of expenditures.

Impact on Taxpayers

Over the last decade, depreciation provisions have changed almost annually. ATRA extended many of these favorable provisions through 2013. The future of these extenders will likely be decided when, and if, Congress implements comprehensive tax reform. These provisions, while advantageous to businesses, merely shift the timing of when taxes are due. As such, taxpayers need to plan and apply these changes correctly, as they likely will have a significant impact on an entity’s taxable income now and in future years.

EditorNotes

Kevin Anderson is a partner, National Tax Services, with BDO USA LLP, in Bethesda, Md.

For additional information about these items, contact Mr. Anderson at 301-634-0222 or kdanderson@bdo.com.

Unless otherwise noted, contributors are members of or associated with BDO USA LLP.