Depreciation
With the economy turning around, many businesses are expanding. This often means they are purchasing new vehicles to update their aging fleets. If these vehicles are passenger automobiles, they are listed property and are subject to limits on the amount that can be deducted for regular depreciation, as a bonus depreciation allowance, and as a Sec. 179 expense.
Application of the Limits
Due to the misleading title given to Sec. 280F (Limitation on depreciation for luxury automobiles; limitation where certain property used for personal purposes), the limits on depreciation and Sec. 179 expense deductions are often referred to as the "luxury automobile" limits. However, the limits apply to any passenger automobiles (other than trucks or vans) that cost over $15,800 in 2014 and trucks and vans that qualify as passenger automobiles that cost over $17,300. This includes the vast majority of newly purchased vehicles, most of which would not be thought of as luxury automobiles in the conventional sense.
For vehicles that cost less than these amounts, the depreciation limitations do not apply because the full amount of modified accelerated cost recovery system (MACRS) depreciation allowed is less than the limitation amounts. While relatively few new vehicles are likely to escape the limits, many used vehicles will probably fall under them.
Passenger Automobiles
A passenger automobile includes any four-wheel vehicle that is manufactured primarily for use on public streets, roads, and highways, and that is rated at 6,000 pounds gross vehicle weight or less. There are two sets of depreciation limit amounts under Sec. 280F, one for passenger automobiles other than trucks and vans (autos) and one for trucks and vans, which include passenger automobiles that are built on a truck chassis, such as some minivans and sport utility vehicles (SUVs). Significantly, for autos, the 6,000-pound limit is based on the unloaded gross vehicle weight of the auto, while for trucks and vans, the 6,000-pound limit is based on loaded gross vehicle weight, which includes passengers and cargo. This means that most full-size pickups and larger vans will be over the 6,000-pound limit and not subject to the Sec. 280F depreciation limits.
Depreciation limits for autos: The depreciation limits for autos that were placed in service in 2014 and used 100% for business are shown in Exhibit 1. The 2015 amounts are expected to be released in February or March 2015.
If the auto qualifies for bonus depreciation, discussed below, and the taxpayer does not elect out, the first-year limit amount is increased by $8,000. Where the taxpayer's business use of an auto is less than 100%, the limits are reduced proportionally to reflect the taxpayer's business use.
Example 1: T buys a new car in 2014 that costs $25,000 and qualifies as a passenger automobile. In 2014, T used the car 75% of the time in his business. T elected not to claim a Sec. 179 deduction for the car and elected out of bonus depreciation. The maximum amount that T is allowed to deduct under Sec. 280F is $2,370 (75% of $3,160).
Depreciation limits for trucks and vans: The depreciation limits for trucks and vans placed in service in 2014 and used 100% for business are shown in Exhibit 2.
If the truck or van qualifies for bonus depreciation, discussed below, and the taxpayer does not elect out, the first-year limit amount is increased by $8,000. As with an auto, when a taxpayer's business use of a truck or van is less than 100%, the limit amounts are reduced proportionally to reflect the taxpayer's business use.
Sec. 179 expense deduction: A Sec. 179 expense deduction can also be taken for passenger automobiles, but the Sec. 280F limits apply to Sec. 179 expense deductions as well as regular depreciation. For example, in 2014, the Sec. 280F limit for trucks and vans that are subject to the passenger automobile limits is $3,460, so the combined Sec. 179 expense and regular depreciation deductions for a truck or van purchased in 2014 cannot exceed $3,460. Taxpayers can take a Sec. 179 expense deduction for new and used vehicles.
Bonus depreciation: Under the bonus depreciation rules, an extra 50% depreciation deduction is allowed for qualifying property in the first year it is placed in service. Passenger automobiles qualify for bonus depreciation if they are new vehicles that are used more than 50% for business and the taxpayer did not elect out of bonus depreciation. Under these rules, the depreciation limit for a passenger automobile that qualifies for bonus depreciation is increased by $8,000 for the first tax year. The $8,000 amount is not adjusted for inflation.
Interaction between the deductions: If a passenger automobile qualifies for the Sec. 179 expense deduction and bonus depreciation, and the taxpayer elects to apply both provisions in the year the passenger automobile is purchased, the taxpayer first determines the Sec. 179 expense deduction, next the bonus depreciation deduction, and then the regular depreciation deduction. The Sec. 179 expense deduction is calculated on the cost of the auto, the bonus depreciation deduction on its cost less the Sec. 179 expense deduction, and the regular depreciation amount on its cost less the Sec. 179 expenses deduction and the bonus depreciation deduction. However, the amount that is deducted cannot exceed the Sec. 280F depreciation limit (including the extra $8,000 for bonus depreciation) for the year.
Example 2: In 2014, T purchased a new passenger automobile (not a truck or van) that she used 100% in her business that qualifies for both bonus depreciation and the Sec. 179 expense deduction. T made other purchases for her business that qualify for the Sec. 179 deduction during the year, and only has $5,000 left that she can take as a Sec. 179 expense deduction for the auto. The automobile cost $18,000.
T's Sec. 179 amount is $5,000, the remaining amount available to take as a Sec. 179 deduction. Her bonus depreciation deduction is $6,500 (50% × [$18,000–$5,000]). Her regular depreciation deduction (using the half-year convention) is $1,300. However, because of the Sec. 280F limit, she can only deduct in total $11,160 ($3,160 + $8,000) of the $12,800 that is otherwise deductible. She therefore is allowed a Sec. 179 expense deduction of $5,000, a bonus depreciation deduction of $6,160, and no regular depreciation deduction for 2014. In 2015 and later years, T can take regular depreciation deductions for the remaining $6,840 of the cost of the auto, subject to the Sec. 280F limits.
Sport Utility Vehicles
SUVs are considered trucks, so SUVs that are less than 6,000 pounds are subject to the Sec. 280F depreciation limits for trucks and vans. However, SUVs over 6,000 pounds gross vehicle weight are not subject to the Sec. 280F limits. SUVs that fall into this category also qualify for the full amount of bonus depreciation allowed in the specific year. In addition, under Sec. 179(b)(5), a Sec. 179 expense deduction of up to $25,000 can be taken for an SUV that is rated at more than 6,000 pounds but not more than 14,000 pounds gross vehicle weight (loaded). No depreciation or Sec. 179 limits apply to SUVs with gross vehicle weights over 14,000 pounds, but very few SUVs are that large. So even though SUVs are not the most practical business vehicles, it might be worth thinking about purchasing one for the depreciation benefits. An SUV over 6,000 pounds gross vehicle weight provides a much larger potential cost recovery benefit than one under the weight limit that qualifies as a passenger automobile.
Trucks and Vans Over 6,000 Pounds
There is no limit on regular and bonus depreciation for trucks and vans that do not qualify as passenger automobiles. As with SUVs, the Sec. 179 expense deduction for trucks and vans rated at more than 6,000 pounds but not more than 14,000 pounds gross vehicle weight (loaded) is $25,000. However, the limit does not apply to trucks and vans in this weight class if the vehicle:
- Is designed to have a seating capacity of more than nine persons behind the driver's seat;
- Is equipped with a cargo area at least 6 feet in interior length that is an open area or is designed for use as an open area but is enclosed by a cap and is not readily accessible directly from the passenger compartment; or
- Has an integral enclosure, fully enclosing the driver compartment and load-carrying device, does not have seating behind the driver's seat, and has no body section protruding more than 30 inches ahead of the leading edge of the windshield.
This means that no limits apply to the Sec. 179 expense deduction or bonus depreciation under Sec. 168(k) if one of these exceptions applies, which will allow many taxpayers to deduct the full cost of a vehicle in the year of purchase. Practitioners must be aware of these definitions to ensure that the Sec. 179 deduction limit is not improperly applied.
Example 3: If a taxpayer purchases a new large pickup truck that has a bed over 6 feet in interior length for $60,000 in 2014 and uses it 100% for business, the business can claim a deduction for Sec. 179 depreciation and/or bonus depreciation of the full $60,000 in the year the vehicle was placed in service.
These rules are in place because most business vehicles are large trucks or vans, and the ability to purchase a vehicle and depreciate the entire cost in the first year to reduce the company's or individual's tax bill encourages business spending. Various websites and tax research products list vehicles over 6,000 pounds gross vehicle weight.
Although taxpayers should not base their business decisions solely on the tax consequences, accelerated depreciation on vehicles over the past few years has provided an incentive to make purchases. While the extension of the rules for bonus depreciation and the increased Sec. 179 expense deduction amounts are useful, it would be helpful if these rules were also made permanent for 2015 and future years, giving certainty to taxpayers and practitioners and helping the U.S. economy to continue to recover by encouraging capital investment.
Reflections
Although there has been no recent discussion about this, Congress should consider making an upward revision to the Sec. 280F limit amounts or changing the rules regarding which vehicles are subject to the limits. Because there is a very real incentive for business owners to abuse the cost recovery rules by purchasing vehicles that are either larger or more luxurious than warranted by business needs, having limits is appropriate. However, the current low levels at which the limits are set and their applicability to almost all vehicles under 6,000 pounds make the limits overbroad, causing them to apply to many vehicles that are purchased for legitimate business reasons.
