How Year-End Purchase of Business Equipment Can Save Taxesby
Bonus first-year depreciation generally isn’t available for purchases of qualifying assets in 2015 unless Congress extends that provision, but year-end purchases of depreciable property still can achieve significant tax savings even if bonus depreciation isn’t revived.
One key for savings is the half-year convention that generally applies in the computation of cost-recovery deductions for the year that property (other than real property) is first placed into service.
Is bonus depreciation gone for good? Bonus depreciation – the ability to claim boosted first-year depreciation deductions for qualifying assets – has been a staple of business year-end planning since it was introduced by the Job Creation and Worker Assistance Act of 2002. However, bonus depreciation is a temporary provision in the Internal Revenue Code, and although it has been extended many times, sometimes retroactively, it is currently in expired status. Unless Congress retroactively reinstates and extends it, bonus depreciation under Code Section 168(k) applies only to qualified property acquired and placed in service after Dec. 31, 2011, and before Jan. 1, 2015 (before Jan. 1, 2016, for certain specialized property).
As year-end approaches, keep a close eye on legislative developments. If Congress does in fact retroactively reinstate and extend bonus depreciation, as it has done many times before, it will amount to windfall savings for 2015 for taxpayers who have already bought qualifying new assets (generally, those with a Modified Accelerated Cost Recovery System [MACRS] recovery period of 20 years or less) and placed them in service this year. A retroactive reinstatement also could mean substantial savings for “last minute” purchases of eligible assets. That’s because the bonus first-year depreciation deduction applies without any proration based on the length of time that an asset is in service during the tax year.
First-year savings under the half-year convention. Because of the half-year convention that generally applies in the computation of cost-recovery deductions for property (other than real property) first placed in service during the current tax year, year-end purchases of depreciable property can achieve significant tax savings even if bonus depreciation is not extended. That’s because the half-year convention treats a business asset placed in service at any time during the tax year as having been placed in service in the middle of that year.
Use caution. Accelerating a purchase into 2015 isn’t always a good idea. For example, it may not produce good results for a taxpayer who has an about-to-expire net operating loss. On the other hand, a taxpayer for whom accelerating the purchase will produce a net operating loss for 2015 that can be carried back to 2013, and who had income taxed at the highest rate in that year, has a good reason to make the purchase in 2015.
Beware of the midquarter convention. The strategy of buying depreciable assets near the end of the year only works if the midquarter convention is avoided. The midquarter convention generally applies to all non-real-estate “Code Section 168 property” placed in service during the year if the aggregate bases of such property placed in service in the last quarter exceed 40 percent of the aggregate bases of all such property placed in service during the year.
Under the midquarter convention, the first-year depreciation allowance for nonrealty property placed in service during the year depends on the number of quarters an asset was in service during the year. Assets placed in service at any time during a quarter are treated as placed in service at the midpoint of the quarter. If the midquarter convention applies, assets placed in service in the first quarter get 10 1/2 months of depreciation; in the second quarter, 7 1/2 months of depreciation; in the third quarter, 4 1/2 months of depreciation; and in the final quarter, 1 1/2 months of depreciation.
If most of a taxpayer’s earlier equipment purchases for the year were placed in service during the third quarter, a business that wants maximum first-year depreciation deductions should try to avoid placing more than 40 percent of its depreciable personal property in service during the final quarter.
Careful use of expensing can avoid the midquarter convention. When determining if the midquarter convention applies, the taxpayer excludes that portion of the basis of property that is expensed under Code Section 179. As a result, by expensing the right property, a taxpayer may be able to avoid having to use the midquarter convention.
Using the expensing election to avoid the midquarter convention is an option only for companies that don’t make large capital purchases during the year. Under current rules, for qualified property placed in service in tax years beginning after 2014, the maximum expensing amount is $25,000. And if more than $200,000 of expensing-eligible property is placed in service during the year, the maximum expensing amount is reduced dollar-for-dollar by the excess. Thus, unless Congress changes the rules, no amount can be expensed if $225,000 or more of Code Section 179-eligible property is placed in service during the year.
Other ways of avoiding the midquarter convention. Even if it appears that the midquarter convention will apply, a closer look may show that it can be avoided. The following assets are excepted (along with expensed assets) for purposes of computing whether the midquarter convention applies and in applying this special convention:
- Nonresidential real property, residential rental property, and any railroad grading or tunnel bore. (Code Sec. 168(d)(3)(B)(i))
- Property placed in service and disposed of during the same tax year, unless it is reacquired and again placed in service during that tax year. (Code Sec. 168(d)(3)(B)(ii); Reg. § 1.168(d)-1(b)(3))
- Property excluded from MACRS under Code Section 168(f). (Reg. § 1.168(d)-1(b)(1)) This consists of property depreciated via a unit-of-production or similar method; films, videotapes, and sound recordings; public utility property, if a normalization method of accounting is not used; and property subject to the anti-churning rules.
- The basis of a business car also is excluded if the taxpayer properly elects for the placed-in-service year to claim deductions using the standard mileage allowance method. The election excludes the car from MACRS pursuant to Code Section 168(f)(1). (Rev Proc 97-58, 1997-52 IRB 24, Sec. 5.06(2))
- That portion of basis attributable to the personal-use portion of mixed-use assets (e.g., a self-employed’s car used for both business and personal use) is disregarded. (Reg. § 1.168(d)-1(b)(4)(iii))
Using the midquarter convention to the taxpayer’s advantage. Although the midquarter convention results in lower first-year depreciation deductions for assets placed in service during the second half of the year, it produces larger first-year write-offs than the half-year convention would for assets placed in service during the first half of the year. So arranging to fall within the midquarter convention rule can sometimes work to the taxpayer’s advantage.
Practitioners should carefully work through the computations to make sure there will be savings. There may not be a savings if the assets placed in service early in the year have longer recovery periods than those placed in service during the last half of the year. That’s because the midquarter convention’s first-year deductions for longer-lived assets may not be large enough to offset the loss of the midyear convention’s larger write-offs for shorter-lived assets.
About the author:
Robert Trinz is a senior tax analyst with Thomson Reuters Checkpoint within the Tax & Accounting business of Thomson Reuters.