Businesses got more breathing room to capture a bonus depreciation deduction when President Obama signed the new tax and jobs bill into law last year. In general, the revamped and substantially liberalized provisions contained in The Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 extend the Bush tax cuts for an additional two years, in most cases.
Further, the law extends and expands the additional first-year depreciation to equal 100% — rather than 50% — of the cost of qualified property placed in service after September 8, 2010, and before January 1, 2012. (September 8 is the date on which President Obama first broached the subject of “full expensing” of the cost of qualified property.) It also extends some similar tax benefits as far out as 2014.
The thinking behind the extension was to continue to spur capital spending by U.S. companies. For the past several years, the tax code has allowed for enhanced depreciation deductions with respect to tangible and intangible property, as long as the items met certain requirements. One of the more popular deductions related to this kind of qualified property was the “first-year depreciation” deduction. Under the older rules, an additional first-year depreciation deduction was allowed in an amount equal to 50% of the adjusted basis of qualified property that was placed in service during a specified period. That deduction has been raised to 100% under the new rules, and the time line has been expanded.
While some critical dates have changed under the new law, the mechanics of the deduction remain the same. For instance, the rules apply for both regular tax and alternative minimum tax purposes, but not for purposes of computing earnings and profits (see Section 168(k) of the Internal Revenue Code). In addition, the property must fall into one of the following four categories: (1) property to which the MACRS depreciation system applies (most tangible personal property) with an “applicable recovery period” of 20 years or less; (2) water utility property; (3) computer software (if either “off-the-shelf” or not acquired in a transaction involving the acquisition of assets constituting a business or a substantial portion thereof); or (4) qualified leasehold property that meets three criteria:
• the original use of the property must commence with the taxpayer after December 31, 2007; and
• the taxpayer must purchase the property within the “applicable time period” (after 2007 and before 2011 under the old law; but before 2013 under the new law); and;
• the property must be placed in service after 2007 and before 2011 under the old law, but before 2013 under the new law (or before 2014 in the case of certain long-lived property and transportation property).
In general, an extension of the placed-in-service date of one year is available for income property with a recovery period of at least 10 years and so-called transportation property (tangible personal property used in the trade or business of transporting persons or property). To qualify for the extended placed-in-service dispensation, the property must have an estimated production period exceeding one year and a cost exceeding $1 million.
In these cases, however, the bonus depreciation rules only applied to the extent of the adjusted basis of the property — which is attributable to manufacture, construction, or production before 2011. So a corporation otherwise eligible for additional first-year depreciation under the tax code — specifically Section 168(k) — could elect to claim additional research or minimum tax credits in lieu of computing depreciation under the law. But the deduction is only for “eligible qualified property” placed in service after March 31, 2008, and on or before December 31, 2008.
In addition, the research credit or minimum tax-credit limitation generally was increased by the so-called bonus depreciation amount, which is equal to 20% of bonus depreciation.
Companies that avail themselves of these new benefits will see an increase in their deferred tax-liability balances. This, in turn, may enable them to reduce the valuation allowances, if any, that exist with respect to their deferred tax assets. The reason: the accelerated-depreciation benefits provide a source of taxable income, the presence of which obviates the need for all or a portion of such valuation allowance. The taxable income we are referring to is the reversing “taxable temporary differences” the bonus depreciation creates.
Contributing editor Robert Willens, founder and principal of Robert Willens LLC, writes a weekly tax column for CFO.com.