10.22.10

The Small Business Jobs and Credit Act of 2010, which was signed into law on September 27, contains a number of valuable tax breaks for businesses. The new law's two significant changes come in the form of more generous rules for depreciation write-offs.

Bigger Section 179 depreciation deductions are allowed for qualifying new and used assets that are placed in service in tax years beginning in 2010 and 2011. Under the Section 179 deduction election, many small and medium-sized businesses can instantly depreciate most or all of the cost of many assets in the year in which they are first placed in service.

In addition, qualified real property improvements placed in service in tax years beginning in 2010 and 2011 are also eligible for the Section 179 deduction. Real property costs have never been eligible before.

First-year bonus depreciation of an extra 50 percent is allowed for qualifying new (not used) assets that are placed in service by December 31, 2010. The bonus depreciation break had expired at the end of 2009, but the new law retroactively reinstates it for qualifying assets that are placed in service during calendar year 2010.

Here are the details about businesses eligible for these extended and expanded depreciation tax breaks and the assets that qualify.

Deduction Doubles and Phase-Out Threshold Drastically Increases

The Small Business Act doubles the maximum Section 179 deduction for tax years beginning in 2010 and 2011. For these two years, the maximum write-off is generally increased to a whopping $500,000 (up from $250,000 for tax years beginning in 2009). For tax years beginning in 2012, however, the maximum deduction is scheduled to fall back to only $25,000, unless Congress takes action and the President goes along.
Under a phase-out rule, a business that makes major expenditures on assets that would otherwise qualify for the Section 179 deduction can lose part or all of its write-off. Specifically, the maximum Section 179 deduction for an affected business is reduced dollar for dollar by the amount of qualifying assets in excess of the applicable annual phase-out threshold. For tax years beginning in 2010 and 2011, the new law generally increases the threshold to $2 million (up from $800,000 for tax years beginning in 2009).

The higher threshold means that many more businesses will be eligible for Section 179 deductions for tax years beginning in 2010 and 2011. For tax years beginning in 2012, however, the phase-out threshold will drop to only $200,000 unless another law is passed to increase it.
How can businesses benefit?

Example 1: Let's say a small business adds $500,000 worth of new and used equipment and software during its 2010 tax year. Under the expanded Section 179 deduction, the business can write off the entire $500,000 on its 2010 tax return, as long as the business has positive taxable income after subtracting the Section 179 deduction.

Example 2: A medium-sized corporation adds $2,225,000 of new and used equipment and software during its 2010 tax year. Under the liberalized deduction phase-out rule for tax years beginning in 2010, the company can write off $275,000 on this year's return as long as the company still has positive taxable income after subtracting the Section 179 deduction. ($500,000 maximum Section 179 deduction reduced by the $225,000 excess over the $2,000,000 phase-out threshold). Before the Small Business Act, this company would have been ineligible for a Section 179 deduction due to the phase-out rule.

Big News: Deductions Now Allowed for Real Property Costs

Before the Small Business Act, real property building and improvement costs did not qualify for the Section 179 deduction. Fortunately, the rules have changed. Now, up to $250,000 of qualified real property costs placed in service in tax years beginning in 2010 and 2011 can be immediately written off under the Section 179 deduction privilege.

Qualified real property costs include the following:

• Improvements to the interiors of leased nonresidential buildings. Some costs are ineligible (such as elevators and interior structural frameworks), and the improvements must be placed in service more than three years after the date the building was first placed in service.
• Restaurant building and improvement costs, as long as more than 50 percent of the building's square footage is used for meal preparation and seating for on-premises consumption of meals.
• Improvements to interiors of retail buildings. Some costs are ineligible (such as elevators and interior structural frameworks), and the improvements must be placed in service more than three years after the date the building was first placed in service.

Key Points: The new $250,000 annual Section 179 allowance for qualified real property improvements is part of the overall $500,000 annual allowance for tax years beginning in 2010 and 2011. Special rules apply when a business wants to claim Section 179 deductions for both eligible personal property costs and qualified real property costs. Finally, total Section 179 deductions cannot exceed taxable income before subtracting any Section 179 deductions.

First-Year Bonus Depreciation Reinstated

You may remember 50 percent first-year bonus depreciation, a valuable deduction that expired at the end of 2009. Thanks to the new law, it's back for a return engagement. Your business might be able to combine bonus depreciation with the generous Section 179 deduction for assets placed in service by December 31, 2010.

Reason: Under the expanded Section 179 write-off, an eligible business can immediately deduct up to $500,000 of qualifying new and used assets placed in service in the tax year beginning in 2010. If the business adds a substantial amount of eligible new assets, it can deduct 50 percent of the remaining cost of those assets (after subtracting the Section 179 write-off) under the first-year bonus depreciation break.

As you can see, the Small Business Act creates a potential tax-saving windfall for small and medium-sized businesses that can take advantage of both the expanded Section 179 deduction privilege and 50 percent bonus depreciation. Reason: They can combine these two breaks to offset a big chunk, or maybe all, of their taxable income for the year.
There are some ground rules for the 50 percent bonus depreciation deduction. To be eligible, an asset must meet these three requirements:

• Requirement 1: Be "qualified property" (including "qualified leasehold improvement property"), which is defined below.
• Requirement 2: Be purchased new by December 31, 2010. Used assets do not qualify.
• Requirement 3: Be placed in service by December 31, 2010, or by December 31, 2011 for certain assets with longer production periods (explained below).

What Types of Assets Qualify?

To be qualified property, an asset must fit one of the following descriptions:

• Property with a depreciation recovery period of 20 years or less. This category includes most types of tangible personal property used for business.
• Depreciable computer software that is not amortizable over 15 years. Since the 15-year rule rarely applies, most purchased software is eligible for 50 percent first-year bonus depreciation.
• Qualified leasehold improvement property (explained below).
• Water utility property. This is an arcane asset category. You'll know it if you have it.

Only New Assets with One Exception

An asset is eligible for the 50 percent first-year bonus depreciation break only if its original use commences with the taxpayer. In other words, the asset must be new rather than used. A special exception applies to assets that are sold by a taxpayer and then leased back to the same taxpayer.

Leasehold Improvement Costs Can Qualify Too

The 50 percent first-year bonus depreciation privilege is available for the cost of "qualified leasehold improvement property." To meet this definition, all of the following tests must be passed.

• The improvement must be made to the interior portion of a building. Some costs are ineligible (such as elevators and interior structural frameworks).
• The building must be nonresidential real property.
• The improvement must be made pursuant to, or under, an operating lease by either the party leasing (or sub-leasing) the space or by the landlord, and the space must be occupied exclusively by the lessee (or sub-lessee).
• The improvement must be made more than three years after the date the building was first placed in service.

Extended Deadline for Long-Lived Assets

The placed-in-service deadline for qualifying property with longer production periods is extended to December 31, 2011 (compared to the general December 31, 2010 deadline) for the following types of assets:

• Qualifying property with a depreciation recovery period of 10 years or longer.
• Certain transportation equipment.
• Certain aircraft.

Key Points: Under the extended placed-in-service deadline rule, only the portion of cost that is allocable to periods before January 1, 2011 is eligible for 50 percent first-year bonus depreciation. Costs allocable to later periods must be depreciated under the normal guidelines.

Bigger Write-offs for New Cars and Light Trucks

For a new (not used) passenger auto or light truck that is used more than 50 percent for business and is subject to the unfavorable luxury auto depreciation limitations, the bonus depreciation tax break increases the maximum first-year depreciation deduction by a hefty $8,000, for vehicles placed in service during calendar year 2010.

For a new car purchased and placed in service in 2010, the maximum first-year depreciation deduction is $11,060, thanks to the Small Business Act. The amount is $11,160 for a new light truck or light van purchased and placed in service in 2010.

Important: The full $11,060 or $11,160 amount is only available when the new car or light truck is used 100 percent for business.

Bigger Deductions for New Heavy SUVs Too

As you may know, the maximum Section 179 deduction for a heavy SUV is limited to $25,000. Congress keeps talking about completely eliminating the Section 179 deduction for these gas guzzling vehicles, but it hasn't happened yet. In fact, the 50 percent first-year bonus depreciation break can be combined with the $25,000 Section 179 deduction to make new heavy SUVs placed in service in 2010 into tax-saving machines.

Example: Let's say a small business uses the calendar year for tax purposes. During 2010, the business buys a brand new $65,000 Cadillac Escalade and uses it 80 percent for business. So the depreciable cost of the vehicle is $52,000 (80 percent times $65,000). On the 2010 business tax return, a $25,000 Section 179 deduction can be claimed (as long as the business has positive taxable income after subtracting the Section 179 deduction). Next, the business can write off another $13,500 under the 50 percent first-year bonus depreciation rule ($52,000 minus $25,000 equals $27,000 times 50 percent equals $13,500). Finally, the business can usually write off another $2,700 under the normal depreciation rules ($52,000 minus $25,000 minus $13,500 equals $13,500 times 20 percent equals $2,700). When all is said and done, the first-year depreciation deductions add up to $41,200, which is 79 percent of the business portion of the vehicle's cost!

Key Points: To qualify for the Section 179 deduction and 50 percent first-year bonus depreciation, you must use the SUV more than 50 percent for business, it must be new, and it must have a gross vehicle weight rating (GVWR) of more than 6,000 pounds. You can usually find the GVWR on a label affixed to the inside edge of the driver's door where the hinges meet the frame.

If you are interested in discussing how it affects your company, we would be glad to advise you.

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