September 11 Tax Relief—Electing Out of Mid-Quarter Depreciation

In two recent notices, the IRS announced its intention to issue regulations permitting certain taxpayers to elect not to use mid-quarter convention depreciation rules. Due to the September 11 terrorists attacks, the timing of acquiring and placing property in service was disrupted for many taxpayers, and the Service decided to help these taxpayers avoid possible adverse tax consequences of purchasing property in the fourth quarter. Through no fault of their own, taxpayers may find that more than 40% of personal property was purchased in the last quarter of 2001, triggering the mid-quarter convention depreciation rule under Sec. 168(d)(3)(A). Realizing this could happen, some taxpayers might have delayed purchases until 2002 to avoid possibly lower depreciation allowances.

Notices 2001-70 and 2001-74

Under Notice 2001-70, if the third quarter of a taxpayer's 2001 tax year included Sept. 11, 2001, the taxpayer could elect to use the half-year convention for all personal property placed in service in that year. The typical tax year that fits this example is, of course, a calendar year, but in reality could include a tax year-end as late as February 2002.

The IRS soon realized that other taxpayers with a tax year-end of September, October or November 2001 would not be eligible for the tax relief, even though the timing of their acquisitions might have been affected by the terrorist attacks as well. To expand such relief to those taxpayers, Notice 2001-74 provides that if the fourth quarter of a taxpayer's tax year included Sept. 11, 2001, the taxpayer could make a similar election to use the half-year convention.

To make the election, the words "Election Pursuant to Notice 2001-70" must appear at the top of Form 4562, Depreciation and Amortization, to be included with the return filed for the tax year that included Sept. 11, 2001.

Certain taxpayers, however, should not use Form 4562 to claim depreciation, but rather Form 2106, Employee Business Expenses, to report employee business expenses. This applies to employees deducting actual job-related vehicle expenses instead of standard mileage rates. A taxpayer in this situation must also write "Election Pursuant to Notice 2001-70" at the top of Form 2106, to make an election. Taxpayers filing a return electronically should enter the same phrase in the Election Explanation record when submitting either Form 4562 or 2106.

Caution: Before electing out of the mid-quarter depreciation, taxpayers should determine whether the mid-quarter convention results in a smaller depreciation deduction in the first year, an assumption commonly made. Depending on the timing and the amounts of the purchases throughout the year, the mid-quarter convention may in fact provide a larger overall depreciation deduction. This will occur if the taxpayer purchased large assets in the first quarter, because the mid-quarter convention allows 10¹/2 months of depreciation (rather than only the six months allowed under the half-year convention). The timing of acquisitions determines which convention provides the greatest depreciation.

Conclusion

Until Congress amends regulations under Sec. 168 to incorporate the new election, taxpayers can rely on Notices 2001-70 and 2001-74 as guidance.

From Edmund D. Fenton, Jr., CPA, DBA, Associate Professor of Ac-counting, Eastern Kentucky Uni-versity, Richmond, KY (Not affiliated with Baker Tilly International)