QBU Rules for Luxury Automobiles

Most tax advisers are familiar with the greater-than-50% business use requirement for listed assets, including luxury automobiles. The qualified business use (QBU) rules are quite stringent and somewhat complicated.

Overview

Sec. 280F limits depreciation for luxury automobiles (passenger vehicles exceeding a purchase price of $15,200); depreciation is further limited when the QBU is 50% or less. Exhibit 1 below lists the 2003 depreciation caps (including Sec. 179 expense) for luxury automobiles with greater-than-50% QBU (see Rev. Proc. 2003-75).

QBU

Section 280F(b)(3)s QBU test must be met annually, and must be supported by a contemporaneous log. If QBU slips below 50% in any year, Sec. 280F(b)(2) states that any depreciation (including Sec. 179 expense) must be recaptured to the extent it exceeded the alternative modified accelerated cost recovery system (MACRS) depreciation required for listed property with less-than-50% business use.

Under Temp. Regs. Sec. 1.280F-3T(e), alternative depreciation is calculated using the Sec. 168(g) straight-line method over the assets earnings and profits (E&P) life. The E&P life, in the case of an automobile otherwise deemed five-year property, is 12 years, significantly restricting depreciation. Sec. 179 and bonus depreciation are not available for an automobile that fails the QBU test.

QBU generally means use in a taxpayers trade or business, but it does not apply to use in a real estate investment business. According to Temp. Regs. Sec. 1.280F-3T, QBU does not include use in an investment or other activity conducted for the production of income within the meaning of Sec. 212.

Under Sec. 280F(d)(3), QBU includes all personal or business use by employees, but only if personal use is reported as compensation to the employee and withheld on by the employer. However, according to Sec. 280F(d)(6)(C), personal use by 5%-owners and related parties, although included in compensation, is not QBU.

Not only is QBU used to determine the depreciation limits of listed property, but also Sec. 179 property. Property purchased for use in other than an active trade or business does not qualify for Sec. 179 treatment.

Weight

Sec. 280F(d)(5)(B) provides that vans and trucks that have been specially modified so that they are not likely to be used more than minimally for personal purposes are exempt from the luxury automobile depreciation limits. Under Sec. 280F(d)(5), vans and trucks rated at over 6,000 pounds gross vehicle weight (GVW) are also exempt, but still subject to the QBU rules.

Example 1: Y, a real estate investor, purchases a Hummer for use in his business. Ys business consists of purchasing and holding rental properties, visiting his property to supervise construction and repairs and looking for new property. Y also uses the vehicle for personal use. His contemporaneous log, required in case of IRS audit to support the business use, puts investment use at 60%. Thus, Y expects to deduct 60% of the Hummers purchase price under Sec. 179.

The Hummers GVW exceeds 6,000 pounds, so it is not subject to the listed-property limits. However, because Y holds assets for the production of income, the Hummer was not purchased for the use in the active conduct of a trade or business and, thus, is ineligible for Sec. 179 treatment; it must be depreciated according to its MACRS class, over five years.

Example 2: In 2003, Y from Example 1 purchases a $50,000 Lexus instead, sacrificing his expected Sec. 179 deduction. The Lexus, at less-than-6,000-pounds unloaded GVW, is a passenger automobile subject to the luxury automobile rules. Because Ys QBU is zero, Y must depreciate the vehicle over its E&P life, using the straight-line method. For five-year property, the E&P life is 12 years. First-year depreciation is $1,250 (($50,000/12 years) x half-year convention x 60% business use).

Example 3: In 2004, Ys log indicates that business use dropped to 40%. Second-year depreciation is $1,667 (($50,000/12 years) x 40% business use).

Example 4: In 2005, Y decides to leverage his experience into a real estate management business. He soon has many clients, and decides to trade in his Lexus for a Hummer. During the period after he acquired the Hummer, his mileage log shows 55% devoted to his new real estate management business, 30% to his investment property and 15% to personal use. Because the real estate management business is an active trade or business under Sec. 168, and the Hummer is not subject to the listed-property limits, Y can elect to expense the portion of the Hummer used in the active trade or business against his management income, and depreciate the portion of the remaining basis used in both businesses over five years.

The Sec. 179 expense is the lesser of 55% of the total purchase price or the net income from the management business (before the Sec. 179 deduction); additional depreciation is calculated on 85% of the remaining basis. If the Hummers purchase price was $80,000, Ys income from his management business before Sec. 179 expense was $40,000, and Ys only other income was $50,000 from the real estate investments, the Sec. 179 deduction would be limited to $40,000, from the $44,000 that would have been allowed if Y had sufficient income from an active trade or business ($80,000 x 55% QBU). The remaining $40,000 basis ($80,000 $40,000) is multiplied by total business use to arrive at depreciable basis, or $34,000 ($40,000 x 85% total business use). If the property qualifies for bonus depreciation, Y can expense $17,000 more in 2005. The remaining $17,000 ($34,000 $17,000) will be depreciated over five years, using MACRS.

Example 5: In 2006, despite his tax advisers admonition that Y use the Hummer in his real estate management business for more than 50% of its total use as long as he owns it, Y discontinues his management business. His mileage log shows 40% use for the production of income, 20% QBU and 40% personal use. Y must recapture 2005s Sec. 179 expense, as well as any depreciation taken in excess of that allowed under the E&P-life method.

From Susan Day, CPA, Gray, Gray & Gray, LLP, Westwood, MA