From Federal Tax Updates Checkpoint Newsstand May 31, 2011
Businesses that trade in machinery or equipment for which they claimed bonus depreciation under Code Sec. 168(k) may qualify for another bonus depreciation deduction on the remaining depreciable basis if they swap for like-kind property that also is eligible under Code Sec. 168(k). In effect, the business gets two bonus depreciation deductions for its expenditure on the traded-in property. What’s more, this result is explicitly OK’d by the regs.
Background. Bonus first-year depreciation deductions are available for a property if: (1) it is property to which the modified accelerated cost recovery system (MACRS) rules apply with a recovery period of 20 years or less, computer software other than computer software covered by Code Sec. 197, qualified leasehold improvement property, or certain water utility property); (2) its original use commences with the taxpayer; and (3) it is timely bought and placed in service by the taxpayer.
The bonus first-year depreciation allowance is:
• 50% of the cost of qualified property acquired and placed in service after Dec. 31, 2007, and before Sept. 9, 2010;
• 100% of the cost of qualified property acquired and placed in service after Sept. 8, 2010 and before Jan. 1, 2012 (before Jan. 1, 2013 for certain longer-lived and transportation property); and
• 50% of the cost of qualified property acquired and placed in service after Dec. 31, 2011 and before Jan. 1, 2013 (after Dec. 31, 2012 and before Jan. 1, 2014 for certain longer-lived and transportation property). (Code Sec. 168(k)(2), Code Sec. 168(k)(5))
Note that 50% bonus depreciation also applied for certain qualified property acquired after May 5, 2003 and before Jan. 1, 2005, and 30% bonus depreciation applied for certain qualified property acquired after Sept. 10, 2001, and before May 6, 2003.
MACRS property may be acquired (1) in exchange for MACRS property in a Code Sec. 1031 like-kind property exchange, or (2) to replace involuntarily converted MACRS property in a Code Sec. 1033 involuntary conversion. (Reg. § 1.168(i)-6(c)(1)) The replacement property is for depreciation purposes divided into the depreciable exchanged basis (i.e., remaining basis of the relinquished property carried over to the replacement property), and the depreciable excess basis (i.e., additional consideration to acquire the replacement property). Where the properties share the same recovery class and depreciation method, the depreciable exchanged basis is written off over what’s left of the relinquished property’s recovery period; and the depreciable excess basis is in effect treated as a separate property with a recovery period that begins anew. (Reg. § 1.168(i)-6(c)(3)(ii))
Double helping on bonus depreciation. When otherwise eligible MACRS property or computer software is acquired via a Code Sec. 1031 like-kind exchange or as a result of a Code Sec. 1033 involuntary conversion, both the carryover basis and the excess basis, if any, of the acquired property are eligible for bonus depreciation. (Reg. § 1.168(k)-1(f)(5)(iii)(A)) What’s more, it doesn’t matter if bonus depreciation was claimed on the old property. (Reg. § 1.168(k)-1(f)(5)(vi), Ex. 3)
RIA illustration: In January of 2010, ABX Corp. bought a new refrigerator truck (5-year MACRS property) for $100,000 and placed it in service that year. In 2011, ABX acquires another new, higher-capacity refrigerator truck in exchange for the truck bought in 2010 by trading in that truck and paying $50,000 cash. ABX uses the optional rate tables to compute depreciation and is subject to the half-year convention in 2010 and 2011.
For 2010, ABX claimed 50% bonus first-year depreciation for the truck bought and placed in service that year. As a result, its 2010 depreciation deduction for the truck was $50,000 of bonus depreciation (.50 × $100,000) plus $10,000 of regular first-year depreciation allowance (.20 recovery year one table percentage for 5-year property × [$100,000 − $50,000 bonus depreciation]), for a total of $60,000.
For 2011, ABX claims an $8,000 depreciation deduction (.32 recovery year two table percentage for 5-year property × [$100,000 − $50,000 bonus depreciation] × 6/12 [half-year convention applies]) for the relinquished truck.
ABX may claim a 100% bonus first-year depreciation deduction for the $32,000 remaining depreciable basis of the relinquished truck, i.e., the depreciable exchanged basis ($100,000 cost − $60,000 − $8,000). ABX also may claim a 100% bonus first-year depreciation deduction for the $50,000 in cash that it pays to acquire the upgraded refrigerator truck.
RIA observation: In essence, for bonus depreciation purposes, the regs treat a taxpayer like ABX as if it had sold the old truck for its remaining depreciable basis and then used the proceeds, along with additional cash, to purchase a new one.
RIA caution: This won’t work if the older-model truck was acquired in January of this year and the newer model in December. Under Reg. § 1.168(k)-1(f)(5)(iii)(B), bonus depreciation isn’t allowable for the exchanged (or involuntarily converted) MACRS property if the exchanged (or involuntarily converted property) is placed in service and disposed of in a like-kind exchange or involuntary conversion in the same tax year.