Now May Be the Time to Buy Capital Assets

By Marcia Richards Suelzer, Toolkit Staff Writer

Bonus depreciation and the enhanced expensing election offer outstanding opportunities to acquire needed assets and greatly minimize your tax liability. However, if you hesitate you will lose out on substantial tax savings because both provisions will be substantially reduced in 2012.

Bonus depreciation and the enhanced expensing election offer outstanding opportunities to acquire needed assets and greatly minimize your tax liability. However, if you hesitate you will lose out on substantial tax savings because both provisions will be substantially reduced in 2012.

Bonus Depreciation

Business assets--ranging from equipment to buildings--that are expected to last more than one year are considered capital assets. Generally, you recover the cost of this property by claiming depreciation deductions that allow you to deduct only a portion of the cost over the life of the assets. However to spur investment in these longer-lived assets, which are usually essential to business growth, Congress provided an accelerated first-year depreciation deduction known as bonus depreciation.

Right now--and through the end of 2011--the bonus depreciation amount is 100 percent of the cost of qualified property. The bonus depreciation amount is scheduled to drop to only 50 percent on January 1, 2012, unless Congress can agree upon an extension.

Think Ahead. Although the bonus depreciation percentage drops to 50 percent for 2012, the really bad news hits in 2013. As the law stands now, bonus depreciation vanishes completely after December 31, 2012.

Effectively using bonus depreciation can make a substantial difference, not only in your taxes, but in your cash flow.

Example. On November 27, 2011, RGS, Inc.. purchases a new boat, costing $400,000, for use in its charter fishing business; it places the boat in service on December 27, 2011. (Property must be both acquired and placed in service before 2012 in order to be eligible for the 100 percent deduction.) Because RGS can claim the 100 percent bonus depreciation deduction, and it can deduct the full $400,000 on its 2011 income tax return.

If this amount is more than RGS's income for the year, RGS will have a net operating loss (NOL). This can be especially valuable if RGS had taxable income in 2010 or 2009 because it can recompute its tax liability and file for a refund of taxes paid. This can provide an infusion of cash into the business, as well as a tax savings. Plus, any NOL not used up during the two-year carryback period is carried forward for 20 years or until it is fully utilized by offsetting future income.

Electing out of bonus depreciation. Bear in mind, that bonus depreciation is not really a "bonus" of an extra deduction. Rather, it is a way to time when you get to deduct the amounts that you are entitled to deduct. In many cases, speeding up the deduction can be very valuable. However, in tax law, there are never any absolute, hard-and-fast techniques that work for everyone. For this reason, you can elect not to use bonus depreciation and depreciate the property under the normal rules for that type of property.

You may want to consider foregoing bonus depreciation if you expect your income to increase substantially over the next years. In that case you may want to spread out the deduction to reduce future income. Also, if you anticipate selling the property in a relatively short period of time, you may want to forego bonus depreciation and claim depreciation deductions over the standard period of time for that type of property. This will lessen the amount of depreciation "recaptured" -- upon a sale, the amount claimed as depreciation will be taxed at regular income tax rates, rather than the lower capital gain rates, up to the amount of gain from the sale.

Example. In 2011, Rick purchased, and placed in service, a new machine that cost $200,000. He took advantage of the 100 percent bonus depreciation to deduct the full amount from his 2011 tax return. In 2014, he sells the machine for $150,000. Because he claimed the full amount of depreciation, his basis in the machine is zero. Therefore, the full $150,000 is taxable gain. All of that gain will be taxed at the ordinary income rates, which are likely to be much higher than the capital gains tax rate.

Business vehicles pose special problems. Special--and complicated--rules apply to business vehicles subject to the "luxury vehicle" rules. The IRS has provided a safe harbor to simplify the interaction between the 100 percent bonus depreciation provision and the luxury vehicle caps, but you should still work closely with a tax professional before you make a vehicle purchase so you are fully informed of the tax ramifications.

Expensing Election

Bonus depreciation is only one way to increase the amount that you can deduct in the first year you place a capital asset into service in your business. The other option is to make an expensing election for some or all of the cost of the property. Although both bonus depreciation and the expensing election can have the same impact on your tax liability, they each have different rules and requirements. For example, bonus depreciation can be claimed only on truly new property; the expensing election can be claimed on "new-to-you" used property.

Unlike bonus depreciation, the amount that you can elect to expense is limited by both a maximum dollar amount permitted and the dollar value of property you acquire during the year. Like bonus depreciation, the amounts allowed under the expensing election are far more generous in 2011 than they will be in 2012.

In 2011, the maximum amount you can expense is $500,000. This will drop to the inflation-adjusted amount $139,000 in 2012. However, the maximum amount is reduced by the amount that your cost of qualified property exceeds an "investment limit." For 2011, the investment limit amount is $2 million. It will drop to the inflation-adjusted amount of $560,000 in 2012.

Not only are the current expensing limits more generous, the current law applies to types of property not normally eligible for expensing. Until the end of 2011, you can elect to expense up to $250,000 of the cost of many improvements made to leaseholds, restaurants and retail establishments that meet certain criteria. This is especially helpful if you own a restaurant or retail store because you cannot claim bonus depreciation for improvements made to that type of property.

Act Now. The generous expensing account limits and the expansion of expensing to include qualified leaseholds, restaurants and retail stores are set to expire at the end of the year. By acting now, most small business can take advantage of these provisions and claim a current deduction for nearly all of their 2011 capital asset purchases. As with bonus depreciation, this not only can help lower your 2011 tax liability, but can help with overall cash flow.

The choice between bonus depreciation and expensing is not an "either-or" choice, provided that the property qualifies for both. You can elect to expense a portion of the cost of an asset and claim bonus depreciation on the remainder. Your tax professional can help you walk through the best strategy to use either of both of these tax-lowering options.