Fixed Asset Purchases in 2013 – What Are the Tax Breaks?

Nancy Hawes, Managing Director, Tax Practice
September 2013

For several years, businesses have enjoyed some advantageous ways of treating fixed asset purchases for tax purposes. Rather than deducting depreciation solely over the life of the asset as is often done for book purposes, we have been able to recover the costs for federal tax purposes in two accelerated ways:

Bonus Depreciation – This allows additional depreciation deductions equal to 50% of the adjusted basis of qualified property placed in service before January 1, 2014. Additionally, the remaining 50% of the cost is depreciated over the tax life of the asset.  Most fixed asset purchases made by financial institutions other than real property would fall under the definition of qualified property; however the property’s “original use” must commence with the taxpayer – in other words, only new property will qualify.

Section 179 Expense - Under Internal Revenue Code Sec. 179, businesses can elect to deduct as an expense, rather than to depreciate, up to a specified amount of the cost of new or used tangible personal property placed in service during the tax year. (Note that unlike bonus depreciation, used property qualifies for expensing.)

For tax years beginning in 2013, the dollar limitation on the expensing deduction is $500,000.  The maximum annual expensing amount generally is reduced dollar-for-dollar by the amount of Code Sec. 179 property placed in service during the tax year in excess of a specified investment ceiling; for tax years beginning in 2013, that ceiling is $2,000,000. (So under the current limits, the Code Sec. 179 deduction doesn’t phase out completely until the cost of expensing-eligible property exceeds $2,500,000 ($2,000,000 investment ceiling + $500,000 dollar limit). In addition, the amount eligible to be expensed for a tax year can’t exceed the business’ taxable income.

Examples
Bonus Depreciation Example: Bailey Bros. Building & Loan, a calendar-year bank, needs to buy $1,000,000 of five-year MACRS property (e.g., computer equipment). If it does so before Jan. 1, 2014, and places the property in service before that date, Bailey may claim a first-year depreciation allowance of $600,000 [($1,000,000 × .50 = $500,000 bonus depreciation) + ($1,000,000 − $500,000 × .20 = $100,000 regular first-year depreciation)].

Section 179 AND Bonus Depreciation Example: In the above example, if its fixed asset purchases for the year are under $2 million, then Bailey could expense $500,000 of equipment before even taking depreciation. The bonus depreciation on the remaining $500,000 would be $250,000, and the regular depreciation on the rest would be $50,000 – for a total deduction in the first year of $800,000.

Same Example without Bonus Depreciation or Section 179: if bonus depreciation or section 179 were not available on this property, the deduction for the first year would only be $200,000 (20% of $1,000,000).

Summary of First Year Tax Deduction for $1 Million Equipment Cost:
No Tax “Breaks” – $200,000
Bonus Depreciation - $600,000
Bonus Depreciation + Section 179 - $800,000

What’s Scheduled to Happen Next Year?
Under current law, bonus depreciation will not generally be available in 2014.  For tax years beginning after 2013, the Section 179 maximum expensing limit is scheduled to drop to $25,000, and the investment ceiling is scheduled to drop to $200,000.

What Does the Crystal Ball Say?
Last month the Congressional Research Service (CRS) released a report examining the tax impact of the current bonus depreciation and Section 179 provisions, as well as proposed changes to these provisions. In general the report concluded that these provisions have only a minor impact on the economy and are an ineffective tool for stimulating the economy. Nevertheless they enjoy substantial support within the business community, especially for smaller businesses (whose lower level of investment allows them to qualify for section 179).

Bonus depreciation – there are proposals in Congress that would extend or expand bonus depreciation allowances; however the President’s 2014 budget request contains no provision for extending bonus depreciation into 2014.

Section 179 – proposals vary from repealing all limitations on its use to permanently setting the limits at a fixed amount (indexed for inflation). The President’s budget request calls for keeping the existing limits ($500,000 expensing limit and $2 million phaseout threshold). Given the popularity and broad support for higher limits, it is unlikely that we would actually return to the $25,000 limit scheduled to come back into effect next year – however, as we know with Congress, nothing is ever a certainty.

State Tax Implications
There is very little consistency in states’ treatment of bonus depreciation and Section 179 deductions. Maine and Massachusetts allow the same amount of Section 179 expense allowed for federal purposes, but New Hampshire only allows $25,000. Maine, Massachusetts and New Hampshire require companies to add back bonus depreciation. However, Maine allows businesses to take a capital investment credit equal to 9% of the cost of the bonus depreciation property. For Maine financial institutions taxed as banks (whose tax is based on book income and assets), the addback of the bonus depreciation amount is irrelevant, but the credit is still allowed.

Our Advice?
While these tax breaks MIGHT be extended into next year, a bird in the hand is probably better than two in the bush. For calendar year businesses who will be undertaking year-end planning soon (where did summer go?), if major fixed asset purchases are on the near horizon, purchasing them soon enough to place them in service in the current year might be advisable (as long as the business is profitable and can benefit from accelerated deductions). If a bank is building a branch, remodeling or otherwise undertaking substantial real estate improvements, it usually will be worthwhile to engage in a cost segregation study to carve out the costs that would be eligible for these tax breaks. This article does not cover all of the exceptions or nuances that may occur, so when considering the tax implications of any major purchase, it is always a good idea to confer with your tax advisor.

If you would like to discuss these matters further, please call Nancy Hawes or your usual BNN professional at 1.800.244.7444.

Disclaimer of Liability: This publication is intended to provide general information to our clients and friends. It does not constitute accounting, tax, or legal advice; nor is it intended to convey a thorough treatment of the subject matter.

IRS CIRCULAR 230 DISCLOSURE:
Pursuant to requirements imposed by the Internal Revenue Service, any tax advice contained in this communication (including any attachments) is not intended to be used, and cannot be used, for purposes of avoiding penalties imposed under the United States Internal Revenue Code or promoting, marketing or recommending to another person any tax-related matter.  Please contact us if you wish to have formal written advice on this matter.