Post-JGTRRA Bonus Depreciation

One of the primary business incentives offered by the Jobs and Growth Tax Relief Reconciliation Act of 2003 (JGTRRA), Section 201(a), is a provision under Sec. 168(k)(4) that allows a taxpayer to take a 50% deduction for bonus depreciation during the first year an asset is placed in service. The provision applies to property acquired after May 5, 2003 and before 2005 (2006 for certain long-lived property).

Eligibility

To be eligible, property must be placed in service for the first time (i.e., used property is not eligible) and generally must be subject to the modified accelerated cost recovery system (MACRS) rules (i.e., property required to be depreciated under the alternative depreciation system (ADS) does not apply). Also, the property must fall into one of the following categories:

1. The recovery period cannot exceed 20 years.

2. Computer software (as defined in Sec. 167(f)(1)(B)) subject to general depreciation rules (i.e., depreciable over 36 months).

3. Water utility property.

4. Qualified leasehold improvement property.

The last category is narrowly defined by Sec. 168(k)(3) and includes only improvements to the interior of a nonresidential building subject to the following conditions:

• It must be made pursuant to a lease either by the lessee (or sublessee) or the lessor;

• The part of the building improved must be occupied by the lessee (or sublessee);

• The building must have been in service for more than three years; and

• The improvement cannot result in an enlargement to the building, nor can it be an elevator or an escalator, or an improvement to a common area or the buildings internal structural framework.

Computations

The 50% bonus depreciation is taken off the top, by multiplying the depreciable basis by 50%. The remaining basis is then depreciated over the recovery period for that asset, as specified by the MACRS rules.

In addition, the bonus depreciation may be taken in conjunction with first-year Sec. 179 expensing. The JGTRRA increased the threshold under Sec. 179 to $100,000 from $25,000, subject to phaseout once the total property placed in service during the tax year exceeds $400,000.

Example: T, an individual, buys and places in service on July 1, 2003, a new asset costing $200,000 and no other property. T can take a $100,000 Sec. 179 expense in 2003, leaving a basis of $100,000. The bonus depreciation deduction of 50% is then applied, leaving a basis of $50,000 to be depreciated under the MACRS rules. If this is five-year recovery property, depreciable over five years using the 200% declining balance-switch-to-straight-line method, and the half-year convention is applied, the depreciation percentage for 2003 is 20% (²/5 x ¹/2). Thus, additional $10,000 depreciation is taken ($50,000 remaining basis x 20%). The total depreciation taken on this $200,000 asset in its first year would thus be $160,000 ($100,000 + $50,000 + $10,000). In the second year, depreciation would be $16,000 (32% x $50,000).

Other Rules

No alternative minimum tax (AMT) adjustment is required for property on which bonus depreciation is taken, either in the assets first year or in subsequent years.

Although bonus depreciation cannot be taken on property required to be depreciated under ADS, it is allowed if ADS is used voluntarily.

One exception to the original-use rule is a sale-leaseback, in which a taxpayer buys property from another party and then leases it back to that party. As long as (1) the property is originally placed in service after May 5, 2003 and (2) the leaseback occurs within three months of when the seller originally placed it in service, the property is treated as placed in service by the taxpayer on the date of the leaseback.

Bonus depreciation is treated as a depreciation deduction for purposes of the disposal of an asset under Sec. 1245 and is subject to recapture as ordinary income.

Electing Out

Under Sec. 168(k)(4)(E), a taxpayer may elect out of bonus depreciation. This election can be made for any asset class, and applies to all property in that class put in service in that year. For example, it can be made for all three-year property or all computer software placed in service during a year. In 2003, in which the 30% rule applies through May 5, 2003, and the 50% rule thereafter, a separate election needs to be made for assets within the same class acquired before and after that date. Once the election is made, depreciation is then claimed using the normal MACRS rules. However, if bonus depreciation is not taken and an election has not been made, the taxpayer must treat the property for subsequent depreciation purposes as if bonus depreciation had been claimed (i.e., reduce the basis by the 50% amount and claim depreciation only on the remaining basis).

The election must be made by the due date (including extensions) of the return for the tax year the property is placed in service. The taxpayer must attach a statement to the return stating that the election is being made and specifying the class(es) of property affected. In a consolidated group, the election is to be made on a subsidiary level.

An election can also be made to take 30% bonus depreciation on property otherwise eligible for 50% bonus depreciation. Like the election to opt-out, this election is also made on an asset-class basis, and applies to all property in that class.

New York Liberty Zone Property

Under Sec. 168(k)(2)(C)(ii), property in the New York Liberty Zone (as defined in Sec. 1400L(c)(2)) is generally eligible for 50% bonus depreciation and 30% bonus depreciation under Sec. 1400L(b)(2)), whether used or new. Qualified leasehold improvement property in the New York Liberty Zone is not eligible for bonus depreciation, although it does carry a five-year recovery period.

From Larry Day, CPA, Brown, Dakes, Wannall & Maxfield, P.C., Fairfax, VA