Will Bonus Depreciation Provide the Needed Stimulus in This Sagging Economy?
How you can maximize this incentive.
March 27, 2008
by Mary Bernard, CPA/MST
The concept of bonus first-year depreciation was originally introduced in the 2002 Job Creation and Worker Assistance Act in order to stimulate the economy after the 9/11 tragedy in 2001. This temporary measure was only available for property placed in service before 2005. In an attempt to mitigate the effects of our current worsening economic situation, the Economic Stimulus Act of 2008 has recycled the popular bonus first-year depreciation deduction.
For one year only, calendar year 2008, taxpayers are allowed an additional deduction of 50 percent of the adjusted basis of "qualified property" placed in service during the year. Qualified property includes property subject to MACRS (Modified Accelerated Cost Recovery System) with a recovery period of 20 years or less, computer software not subject to section 197 and qualified leasehold improvement property. The original use of the property must commence with the taxpayer in order to be qualified property.
Maximize the Covered Asset Base
Most tangible property you use in your trade or business has a recovery period of less than 20 years. In addition to capital assets such as machinery and equipment, your bonus allowance is also available for capital goods such as cattle and horses. Qualified property will also include typical 15 year property such as land improvements and landscaping. Sidewalks and roads that are not included in another class of assets and are not buildings or structural improvements are eligible for the bonus allowance. Landscaping qualifies if it is immediately adjacent to buildings and would be destroyed if the building is destroyed or replaced. Farm buildings, other than single purpose agricultural structures, would also be considered qualified property.
Most computer software readily available for purchase by the general public will qualify for bonus depreciation. In general, your computer software is subject to amortization under section 197, thus ineligible for bonus allowance, if it is custom designed, significantly modified from a publicly available software or is acquired with the assets of a trade or business. Off-the-shelf software will normally be considered qualified property.
Building Improvement vs. Building Enlargement
A qualified leasehold improvement is defined as an improvement to the interior of a non-residential building meeting the following conditions:
The improvement is made under a lease agreement by either the lessor, lessee or sublessee of the building;
That section of the building is occupied exclusively by the lessee or sublessee; and
The improvement is placed in service more than three years after the date the building was first placed in service by any person.
There is no definition in the code of what types of building improvements are considered qualified leasehold improvements. Code section 168(k) and related regulations only describe types of property not considered qualified. Ineligible property includes improvements attributable to:
Enlargement of a building;
An elevator or escalator;
A structural component benefiting a common area; and
The internal structural framework of the building.
To understand what an "enlargement" is, as opposed to a qualified improvement, it is necessary to review the regulations issued pertaining to rehabilitation tax credits. Under these definitions, a building is enlarged when its total volume is increased. When only floor space increases due to interior remodeling, this is not considered an enlargement. Total volume of a building is generally equal to the product of the floor area of the base of the building and the height of the building, measured from the underside of the lowest floor, including the basement, to the average height of the finished roof. If the total volume of the building is not increased by the expenditures in question, the improvement should qualify for the bonus depreciation, provided all other requirements are met.
What Is an Eligible Improvement?
Referring again to the rehabilitation tax credit regulations, leasehold improvements eligible for bonus depreciation would include:
Electrical and plumbing systems, including sprinkler systems;
Permanently installed lighting fixtures;
Heating equipment, cooling equipment, air conditioners and other air handling equipment; and
Ceilings and doors.
One stipulation on the above structural components is that the improvements must benefit only the tenant's space and not any common areas. Common areas are generally thought to include stairways, hallways, lobbies, restrooms, pedestrian walkways and loading docks.
Building Components vs. Personal Property
Without the benefit of a detailed cost segregation study, valuable depreciation deductions may be unnecessarily delayed. Not all costs associated with a building should be considered real property. The IRS has considered the following assets to be treated as personal property, many with a five-year recovery period and eligible for bonus depreciation, rather than building components:
Canopies and awnings;
Concrete foundations or footings for signs, light poles and canopies;
Doors and window accessories, including tinting;
Interior and exterior signs;
Floor covering and carpeting;
Decorative millwork, such as detailed crown moldings and lattice work placed over finished walls;
Light poles for parking areas; and
Site grading, including clearing, grading, excavating and stonework.
Noteworthy Unusual Situations
New property initially used personally by taxpayers and subsequently converted by them for use in a trade or business still meets the original use requirement;
A sale-leaseback situation can qualify if less than three months elapses between the original use and the leaseback;
Sale of fractional interests in qualified property can be considered original use by the fractional owners;
Technical terminations of partnerships involving property contributed by the terminating partnership to a new partnership may still qualify for bonus depreciation;
No pro-ration is required for a short tax year or for the period of time the property is placed in service during the year; and
An "election out" is available in the case where an expiring NOL, for example, may provide a larger tax advantage than bonus depreciation. The election is made by property class and applies to all property in that class placed in service during the year.
The correct classification of all newly acquired fixed assets can greatly improve your bottom line by maximizing this temporary, potentially significant tax incentive.
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Mary F. Bernard, CPA/MST is a Tax Principal and Director of State and Local Tax Services at Kahn, Litwin, Renza & Co., Ltd. in Providence, RI. She has over 20 years of experience with national and local accounting firms working with a variety of individual, partnership and corporate clients, with particular focus on corporate multi-state tax issues. She has also provided advisory and compliance services to extensive nonprofit clients. Bernard is a member of the AICPA, the Massachusetts Society of CPAs and serves as President-elect of the board of directors for the Rhode Island Society of CPAs.