Capital Expenditures: What a Relief
By Andrea Bains, Tax & Business Services
The recently enacted 2010 Tax Relief Act includes a wide-ranging assortment of tax changes affecting both individuals and business. On the business side, the most significant changes provide incentives for businesses to invest in machinery and equipment by allowing for faster cost recovery of business property.
Expansion and extension of additional first-year depreciation
Businesses are allowed to deduct the cost of capital expenditures over time according to depreciation schedules. In previous legislation, Congress allowed businesses to rapidly deduct capital expenditures of most new tangible personal property, and certain other new property, placed in service in 2008, 2009, or 2010 (2011 for certain property), by permitting the first-year write-off of 50% of the cost. The new law extends and temporarily increases this additional first-year depreciation provision for investment in new business equipment. For investments placed in service after September 8, 2010, and through December 31, 2011, (through December 31, 2012, for certain longer-lived and transportation property), the new law provides for 100% additional first-year depreciation. In other words, the entire cost of qualifying property placed in service during that time frame can be written off, without limit. Note that even though the legislation did not take shape in Congress until mid-December of 2010, the effective date of this provision was made retroactive, to include qualifying property placed in service after September 8, 2010.
50% additional first-year depreciation will apply again for those assets placed in service after December 31, 2011, and before January 1, 2013.
The Act extends through 2012 the election to accelerate the AMT credit instead of claiming additional first-year depreciation.
The new law leaves in place the existing rules as to what kinds of property qualify for additional first-year depreciation. Generally, the property must be (1) depreciable property with a recovery period of 20 years or less; (2) water utility property; (3) computer software; or (4) qualified leasehold improvements. Also the original use of the property must commence with the taxpayer – used machinery does not qualify. .
It should be noted that certain qualified property such as passenger cars are subject to restrictive rules for regular and bonus depreciation. For the 2010 tax year, passenger cars are allowed a maximum 1st year regular depreciation deduction of $3,060 and an additional $8,000 of bonus depreciation. The $8,000 bonus depreciation on initial purchases is extended through the 2012 tax year. .
Enhanced small business expensing (Section 179 expensing)
Generally, the cost of property placed in service in a trade or business can not be deducted in the year it is placed in service if the property will be useful beyond the year end. Instead, the cost is “capitalized” and depreciation deductions are allowed for most property (other than land), and are spread out over a period of years. However, to help small businesses quickly recover the cost of capital outlays for qualifying personal property, small business taxpayers can elect to write off these expenditures in the year of acquisition instead of recovering the costs over time through depreciation. The expense election is made available, on a tax year by tax year basis, under Section 179 of the Internal Revenue Code, and is often referred to as the “Section 179 election”. The new law makes three important changes to the Section 179 expense election. .
First, the new law provides that for tax years beginning in 2012, a small business taxpayer will be allowed to write off up to $125,000 (indexed for inflation) of capital expenditures subject to a phase-out (i.e., gradual reduction) once capital expenditures exceed $500,000 (indexed for inflation). The new maximum expensing amount and phase-out level for tax years beginning in 2012 is actually lower than the levels in effect for tax years beginning in 2010 or 2011 (maximum expensing amount of $500,000, and a phase-out level of $2,000,000). For tax years beginning after 2012, the maximum expensing amount will drop to $25,000 and the phase-out level will drop to $200,000. .
Second, the rule which treats off-the-shelf computer software as qualifying property is extended through 2012. .
Third, the new law extends, through 2012, the provision permitting a taxpayer to amend or irrevocably revoke a Code Sec. 179 expense election for a tax year without IRS’s consent. .
Also, under the 2010 Tax Act, a new property category was created called “qualified real property”. For tax years beginning in 2010 or 2011 qualified real property is treated as section 179 property and subject to a dollar limit eligible for the section 179 deduction. Qualifying property was expanded to include up to a $250,000 deduction of qualified leasehold improvement property, qualified retail improvement property, and qualified restaurant property. .
Leasehold Improvements – Special Deductions
The 2010 Tax Relief Act extends favorable treatment of a 15-year recovery period to qualified leasehold improvement property, qualified retail improvement property, and qualified restaurant property placed in service through the 2011 tax year. Assets that are qualified retail improvement property or qualified restaurant property are not eligible for bonus depreciation and relief from the AMT depreciation adjustments unless they are also “qualified leasehold improvement property”. Qualified leasehold improvement property is any improvement to an interior portion of a building that is nonresidential real property, provided certain requirements are met. The improvement must be made under a lease either by the lessee (or sublessee), or by the lessor, of that portion of the building to be occupied exclusively by the lessee (or sublessee). The improvement must be placed in service more than three years after the date the building was first placed in service. Qualified leasehold improvement property does not include any improvement for which the expenditure is attributable to the enlargement of the building, any elevator or escalator, any structural component benefiting a common area, or the internal structural framework of the building.
Qualified restaurant property is any nonresidential property that is a building (if the building is placed in service after December 31, 2008 and before January 1, 2010) or an improvement to a building, if more than 50 percent of the building’s square footage is devoted to the preparation of, and seating for on-premises consumption of, prepared meals. .
Qualified retail improvement property is any improvement to an interior portion of a building which is nonresidential real property if such portion is open to the general public and is used in the retail trade or business of selling tangible personal property to the general public, and such improvement is placed in service more than three years after the date the building was first placed in service. Qualified retail improvement property does not include any improvement for which the expenditure is attributable to the enlargement of the building, any elevator or escalator, or the internal structural framework of the building. .
The 2010 Tax Relief Act brings significant relief to businesses. It will good to be “in the know” for those companies looking to obtain an immediate tax benefit from their investments. Please contact your local Marcum representative for more information on the 2010 Tax Relief Act. .