Sorting out depreciation rules

We've had three major tax laws in as many years, but it's hard to find much relief in any of them for businesses (though there have been lots of benefits for individuals).

The one major tax break businesses have received and it is a good one is a vastly increased ability to write off fixed asset costs in the year of purchase.

The Jobs and Growth Tax Relief Reconciliation Act of 2003 expanded the limits for fixed asset write-offs under Section 179, and increased first-year bonus depreciation to 50 percent from 30 percent (which was originally introduced in the Job Creation and Worker Assistance Act of 2002 don't you just love these titles?).

The switch from the 30 percent bonus rate to 50 percent applies to assets purchased after May 5, 2003.

Thus, for 2003, you may find yourself using Section 179 on some assets, 30 percent on others, and 50 percent on still others.

Given this, it's wise to review the similarities, the differences, and the potential pitfalls.

As noted, the limits on the Section 179 write-off have been liberalized.

For tax years beginning after 2002 (fiscal year filers, be careful) the Section 179 deduction may be taken on a maximum of $100,000 of asset purchases, but only if total asset purchases for the year are less than $400,000 (after that the deduction phases out on a dollar-for-dollar basis) and only on assets used in active businesses (not passive rentals).

The Section 179 deduction cannot exceed taxable income prior to the deduction, so you can't create a tax loss with it.

Bonus depreciation avoids all these limits, but adds a very important one of its own.

To qualify for bonus depreciation, the property purchased must be new.

If you buy a used piece of machinery, it doesn't count.

It's important to remember that the taxpayer must elect to use Section 179 (and if not properly elected on a timely filed return, that option is lost).

Just to be different, bonus depreciation is mandatory for assets that qualify, but the taxpayer may elect out of the 50 percent rate, and use the 30 percent rate, or elect out of bonus depreciation altogether (again on a timely filed return).

In certain tax situations, there may be reasons to choose regular depreciation rather than one of the quicker write-offs.

The mandatory nature of bonus depreciation caused a lot of initial confusion, primarily because it was first enacted in 2002 affecting 2001 returns, and many taxpayers had to file their returns before the provision was fully explained.

Therefore, the IRS provided additional time for taxpayers to correct their bonus depreciation.

It has recently extended that opportunity to encompass all timely filed returns for tax years that included September 11, 2001 (the starting date for bonus depreciation).

If you think you may have missed out on claiming bonus depreciation originally, now's the time to take another look.

Most real property and improvements don't qualify for these deductions, and automobiles create some special issues, just as they do with all depreciation.

There's a limit on the maximum amount of depreciation that can be taken per year on certain automobiles.

That limit applies to Section 179 and to bonus depreciation as well, but the limit for bonus depreciation is higher.

The available write-offs are limited to the percentage of business use of the car, and if that use drops below 50 percent, Section 179 is not only not available, but if taken in a previous year, may need to be recaptured.

If you have to file income taxes in any state, be aware that not all of them have adopted these federal rules.

Overall, these expanded provisions should provide business taxpayers with strong incentives to invest in fixed assets this year.

However, with the myriad of options available, "crunching the numbers" for tax purposes should be a part of any purchasing plan.

Kirk Gardner,CPA,MST, is a shareholder with Kafoury,Armstrong & Co.

in Reno specializing in tax issues.