Enhanced tax breaks make it an especially good time to buy business autos
Mike Habib, EA
myIRSTaxRelief.com Thanks to economic woes in general and financial trouble for auto manufacturers in particular, it’s a good time to shop for a new vehicle, if you can afford to do so. Thanks to bonus first year depreciation deductions under the Economic Stimulus Act of 2008, it’s an even better time to buy if the vehicle is going to be used for business. This Practice Alert takes a close look at the enhanced first year write-offs that are available to new business autos, light trucks or vans that are placed in service this year.
Bonus depreciation basics. In general, for property placed in service after Dec. 31, 2007, in tax years ending after that date, taxpayers get an additional depreciation deduction in the placed-in-service year equal to 50% of the adjusted basis of “qualified property.” (Code Sec. 168(k)(1)) This is property that meets all of these conditions:
- It is property falling within one of four statutory categories, the most important of which is property to which MACRS applies with a recovery period of 20 years or less. (Code Sec. 168(k)(2)(A))
- The original use of the property commences with the taxpayer after Dec. 31, 2007. Original use is the first use to which the property is put, whether or not that use corresponds to the taxpayer’s use of the property. (Code Sec. 168(k)(2)(A))
- The property is acquired by the taxpayer (a) after Dec. 31, 2007, and before Jan. 1, 2009, but only if no binding written contract for the acquisition is in effect before Jan. 1, 2008, or (b) pursuant to a binding written contract which was entered into after Dec. 31, 2007, and before Jan. 1, 2009. (Code Sec. 168(k)(2)(A)(iii))
- The property is placed in service after Dec. 31, 2007, and before Jan. 1, 2009 (the placed-in-service date is extended for one year for certain property with a recovery period of ten years or longer and certain transportation property). (Code Sec. 168(k)(2)(B), Code Sec. 168(k)(2)(C))
If all of the Code Sec. 168(k) requirements are met, bonus first-year depreciation automatically applies to qualified property, unless the taxpayer “elects out” under Code Sec. 168(k)(2)(C)(iii).
Under pre-Stimulus Act regs that taxpayers may rely on pending further guidance, the bonus depreciation allowance is found by multiplying the qualifying property’s unadjusted depreciable basis by 50%. (Reg. § 1.168(k)-1(d)(1)(A)) The unadjusted depreciable basis is basis for gain or loss purposes, before depreciation, amortization, or depletion, less a number of adjustments, including a reduction in basis for personal use (i.e., use other than for trade or business or investment purposes), and a reduction for any portion of the property expensed under Code Sec. 179. (Reg. § 1.168(k)-1(a)(2)(iii))
To calculate regular depreciation allowances for qualifying property, the taxpayer first subtracts the bonus first year depreciation amount from the unadjusted depreciable basis of the asset. (Code Sec. 168(k)(1)(B), Reg. § 1.168(k)-1(d)(2))
Depreciating luxury autos. Purchased autos and other vehicles used in a trade or business normally are depreciated over five years using 200% declining balance depreciation, with a built-in switch to straight line. (Code Sec. 168(b)(1); Code Sec. 168(e)(3)(B)) Because the depreciation rules generally treat property as placed in service in the midpoint of the placed-in-service year (Code Sec. 168(d)(1)), yielding only half of the otherwise allowable depreciation for the placed-in-service year, the actual depreciation period is six years. The regular depreciation percentages (if the half-year convention applies) are:
- 20% for the first year;
- 32% for the second;
- 19.2% for the third year;
- 11.52% for each of the fourth and fifth years; and
- 5.76% for the sixth year.
However, the deduction normally obtained by applying the above depreciation rules (and the Code Sec. 179 expensing rules) to autos, light trucks and vans, is limited by the so-called “luxury auto dollar caps” of Code Sec. 280F. Thus, the maximum annual depreciation/expensing deduction for a business auto is the lesser of the otherwise allowable depreciation/expensing allowance or the applicable luxury-auto dollar cap.
For vehicles acquired and placed in service in 2008 that are not eligible for bonus depreciation (e.g., they are bought used, or the taxpayer elects out of bonus depreciation for five-year property), the dollar caps for: (1) autos (not trucks or vans) are $2,960 for the placed in service year, $4,800 for the second tax year, $2,850 for the third tax year; and $1,775 for each succeeding year; and (2) for light trucks or vans (passenger autos built on a truck chassis, including minivans and sport-utility vehicles (SUVs) built on a truck chassis) are: $3,160 for the placed in service year, $5,100 for the second tax year, $3,050 for the third tax year; and $1,875 for each succeeding year.
Boosted write-off for business autos, and light trucks or vans. Under the Stimulus Act, for vehicles that otherwise are qualified property under Code Sec. 168(k) (assuming the taxpayer doesn’t elect out of bonus depreciation for 5-year property), the regular first-year luxury auto caps are boosted by $8,000 to $10,960 for autos, and to $11,160 for light trucks or vans.
Calculating first-year depreciation deduction. Where expensing isn’t claimed, the first-year dollar-cap for a new passenger auto, truck or van that is qualified property under Code Sec. 168(k) and is acquired and placed in service in 2008, is determined as follows:
(1) Multiply the vehicle’s depreciable basis by its business/investment use in the placed-in-service year.
(2) Multiply Line (1) result by 50%.
(3) Subtract Line (2) from Line (1).
(4) Multiply Line (3) result by 20% (assuming the half-year convention applies).
(5) Add Line (4) result to Line (2) result.
(6) Multiply the appropriate first-year dollar cap ($10,960 for autos, $11,160 for light trucks or vans) by the business/investment use percentage.
(7) The lesser of Line (5) or Line (6) is the total first-year depreciation allowance for the vehicle.
Illustration 1: On Jan. 10, 2008, a business bought and placed in service a new $35,000 auto and uses it 100% for business. It does not expense any part of the auto’s cost, and the half-year depreciation convention applies. The 2008 depreciation deduction for the auto is computed as follows:
(1) $35,000 × 100% business use = $35,000.
(2) $35,000 × .50 = $17,500 bonus depreciation.
(3) $35,000 − $17,500 = $17,500 remaining basis.
(4) $17,500 × .20 first year depreciation allowance = $3,500.
(5) $17,500 + $3,500 = $21,000.
(6) $10,960 × 1.0 = $10,960.
(7) Lesser of $21,000 or $10,960 = $10,960 regular first year depreciation.
Caution: The combined special depreciation allowance and regular first-year depreciation deduction for lower-priced vehicles may be less than the maximum first-year depreciation allowance.
Illustration 2: The facts are the same as in the first illustration, except that the new auto costs $18,000. The 2008 depreciation deduction for the auto is computed as follows:
(1) $18,000 × 100% business use = $18,000.
(2) $18,000 × .50 = $9,000 bonus depreciation.
(3) $18,000 − $9,000 = $9,000 remaining basis.
(4) $9,000 × .20 first-year depreciation allowance = $1,800.
(5) $9,000 + $1,800 = $10,800.
(6) $10,960 × 1.0 = $10,960.
(7) Lesser of $10,800 or $10,960 = $10,800 regular first year depreciation.
Hidden danger for company owned vehicles. A vehicle is qualified property eligible for bonus first year depreciation only if it is used more than 50% in a qualified business use. (Reg. § 1.168(k)-1(b)(2)(ii)(A)(2)) In general, this isn’t a problem for company owned autos so long as employee personal use is properly treated as compensation income under the fringe benefit rules. In this case, personal use is treated as qualified business use. ( Reg. § 1.280F-6(d)(2) ; Instructions for Form 4562 (2007), p. 9) However, a vehicle bought new in 2008 and provided to a 5% company owner (or a related person) will not be eligible for bonus first year depreciation unless it is actually used more than 50% for business driving. (Code Sec. 280F(d)(6)(C)) Thus, companies tempted by the prospect of larger first year writeoffs to buy new vehicles this year for their 5% owners should do so only if their business mileage on the car will exceed 50% of total mileage. Keep in mind, too, that depreciation recapture applies if qualified business use in the placed in service year exceeds 50% of total use but declines below that level in subsequent years. The 50% bonus first-year depreciation allowance for a passenger auto that qualifies under Code Sec. 168(k) is taken into account in computing recaptured depreciation. (Code Sec. 168(k)(2)(F)(ii))