On February 13, 2008, President Bush signed The Economic Stimulus Act of 2008, which includes bonus depreciation and increased expensing provisions to encourage spending by businesses in 2008. This is very similar to incentives provided by the Job Creation and Worker Assistance Act of 2002. The bonus depreciation is available to all taxpayers, but the expensing provision is only for trades or businesses. Entities who own rental real estate property cannot take advantage of the expensing provisions. Generally, businesses can currently deduct up to $250,000 of 2008 personal property acquisitions used in their business if they do not acquire in the aggregate more than $800,000 and the business still shows a profit after the deduction is taken. Any excess can be carried forward and deducted in future years. The enhanced depreciation provisions allows for 50% of the cost of most personal property and qualified leasehold improvements (defined below) acquired and placed in service during 2008 to be deducted currently in addition to the amount calculated using the applicable convention over the applicable recovery period which is usually 5, 7 or 15 years. There is no limit to the amount of bonus depreciation.
First, let's look at a LLC that owns and rents a commercial office building who places $3 million of qualified leasehold improvements in service during 2008 versus 2009. Depreciation in 2008 could total $1,575,000 versus less than $50,000 if the improvements are placed into service in 2009.
Next, let's look at a simple example of a profitable commercial business that acquires $500,000 of furniture and office equipment, typically depreciated over seven years. If the property was acquired in 2007, they would have been able to deduct $178,588 in year one and $91,838 in year two. Under the new law they will be able to deduct $392,863 in 2008 and $30,613 in 2009 or year two, with the balance depreciated over the remaining six years.
As you can see from the above examples, these provisions can significantly reduce your initial year after tax costs of certain property acquisitions and should be taken into consideration with regards to timing of these acquisitions. If the incentives related to qualified leasehold improvements expire at the end of 2008, it would seem that any improvements accelerated from 2009 to 2008 would greatly reduce the landlord's after tax cost of such an investment. The apparent savings resulting from accelerating personal property acquisitions from 2009 to 2008 is not always what it seems so a more careful analysis is required. For the commercial business, the net present value (at a 10% rate) after tax savings for a taxpayer in a combined federal and state tax bracket of 40% is less than $20,000 and if you are in the alternative minimum tax (AMT) bracket the savings is approximately $13,000. Finally if you were in the AMT or long term capital gain rate position of 28% or less in 2008 and in the maximum ordinary rate of 35% in 2009 and future years, the accelerated deduction could actually be more costly. Therefore, as with most income tax planning, you need to consider your tax position over several years and be informed about your options.
In order to benefit from the enhanced depreciation deductions, the business must meet the following requirements related to:
Type of Property - Includes tangible property with a recovery period not exceeding 20 years, which includes most personal property, land improvements, Qualified Leasehold Improvements (QLI), computer software that is not considered an intangible asset and water utility property.
To be considered a QLI the modifications must be in the interior portions of nonresidential property and are:
Original Use - Must start with the taxpayer - cannot be used property.
Timely Acquisition and Placement in Service - The property must be acquired and placed in service during calendar year 2008, but could not have been subject to a binding contract for the acquisition before January 1, 2008. Property placed in service in 2009 can still qualify if it is considered to have a "longer production period" and meets all of the other requirements. This exception is generally for property with a 10 year life costing more than $1M and most aircraft.
Disqualifying Transactions Rule - Prevents taxpayers from acquiring property from related parties that would not have been qualified if the related party sale did not occur.
Ineligible Property - Property that is subject to the Alternative Depreciation System, which includes property outside of the United States, tax exempt use, tax exempt bond financed, or New York Liberty Zone properties. However, taxpayers can make an election to not apply these rules for increased deductions for otherwise qualified property.
The additional deductions discussed above are permitted for AMT purposes. Although states have not yet had the time to comment, if history follows, it is likely that DC, Virginia and Maryland will not allow the enhanced depreciation deductions.
For additional information on these topics, or to discuss your individual or business tax issues, please contact:
Kelly Toole
Randall Barrus
John Cutler
Matt Hallam
Amelia Hillman
Dwayne Holt
Pete McKenna
Todd Stokes
Katherine Wiernicki
To ensure compliance with requirements imposed by the IRS, any written tax advice contained in this communication (including any attachments) was not written or intended to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code, or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.