Are You Cashing in on "Bonus" Depreciation To Decrease the Net Cost of Your Asset Purchases?
By Gordon Goldie
Construction/Real Estate Advisor, 2004 Issue No. 1
In May 2003, President Bush signed into law the Job and Growth Tax Relief Reconciliation Act of 2003 (the “Act”), providing approximately $350 billion of tax relief. For businesses, the most important aspect of this new Act is the way it significantly accelerates the ability to write off equipment and leasehold improvements. So how can you cash in on these new incentives?
What New Incentives Are Available?
Election to Expense Depreciable Business Assets: Many businesses are familiar with the benefits of Section 179, which permit certain depreciable assets to be expensed in the year they are placed in service. Qualifying assets include most depreciable property used in an active trade or business other than buildings or building improvements. Before enactment of the new law, businesses were generally eligible to expense up to $25,000 of qualifying property. The allowable expense was phased out if total purchase of eligible assets exceeded $200,000 and was eliminated if such purchases exceeded $225,000. The new law increases the annual expense limitation to $100,000 and raises the beginning of the phase out range to $400,000, with a complete phase out if total acquisitions exceed $500,000.
The increases apply retroactively to assets placed in service in tax years beginning after Dec. 31, 2002 and will revert back to the lower limit for years beginning after 2005. The $100,000 annual expense limit and the increased phase out range will be indexed for inflation for years beginning after 2003.
Increased Bonus Depreciation Deduction: The Job Creation and Worker Assistance Act of 2002 created a 30 percent first-year bonus depreciation deduction for new equipment purchased and qualified leasehold improvements made after Sept. 10, 2001. The new law increases the first-year bonus depreciation allowance to 50% for eligible property purchased after May 5, 2003, and extends the benefit to assets acquired through Dec. 31, 2004.
Qualifying assets must meet the same eligibility requirements established by the 2002 Act. Only new depreciable property qualifies and, if a binding contract to purchase the asset was in place before May 6, 2003, the 30 percent deduction rather than the new 50 percent allowance will apply.
Illustration of Potential Savings: A construction company that purchases $300,000 of new equipment and $100,000 of used equipment during 2004 is entitled to deduct $280,000 of such costs in 2004 (70 percent of the total cost of equipment in this example). A construction company that purchases $150,000 of new equipment during 2004 is entitled to deduct $130,000 of such costs in 2004 (approximately 87 percent of the total cost of the equipment in this example).
How Can You Make Real Estate Qualify for Bonus Depreciation?
Real property is generally not eligible for bonus depreciation. However, the following two very important exceptions can help you take advantage of the bonus depreciation incentives to significantly accelerate depreciation deductions associated with real property.
Maximizing Bonus Depreciation With “Qualified Leasehold Improvements: The only real property that is eligible for bonus depreciation is “qualified leasehold improvement property.” Leasehold improvements must meet several conditions to be eligible for bonus depreciation. Qualified leasehold improvement property is most likely to be found in office buildings and retail shopping centers, since improvements to owner-occupied buildings and residential rental property cannot meet the criteria for qualified leasehold improvement property.
Absent bonus depreciation, qualified leasehold improvements are required to be depreciated over 39 years. Consequently, bonus depreciation results in a significant net present value benefit. For example, 50 percent bonus depreciation will increase the first-year deduction on a $100,000 qualified leasehold improvement from approximately $1,500 to more than $50,000.
Using Cost Segregation To Qualify for Bonus Depreciation: One of the keys to realizing the benefits of bonus depreciation when constructing or improving real property lies in the concept of “cost segregation.” To the extent that the cost of constructing or improving the property can be segregated and allocated to personal property components of the building, such costs will be eligible for bonus depreciation, regardless of whether or not they meet the criteria of “qualified leasehold improvements.” Unfortunately, this opportunity is generally not available for taxpayers who acquire previously existing property, because such property generally does not satisfy the original use requirement to qualify for bonus depreciation.
If you have any questions or want more information on how to take advantage of the new tax law, contact Gordon Goldie at 248.375.7430.