1. The bonus depreciation election is an election not to claim it.
While most tax elections allow you to do something (such as claim Section 179 expense or use the MACRS Alternative Depreciation System <ADS>), the bonus depreciation election is an election not to claim it. This is because claiming the deduction for bonus depreciation is not optional; if you place qualifying property in service in a year in which bonus depreciation is allowed, the deduction is mandatory unless an election not to claim it is made.
To make the election not to claim bonus depreciation, attach a statement to a timely filed tax return (including extensions) for the year in which the deduction applies. The election is made either for all property qualifying for bonus depreciation or for one or more specified classes of assets. (For example, you can elect not to claim bonus depreciation for all seven-year property.) The election is an annual election and only applies to property placed in service during the year for which the election is made. For a consolidated group of corporations, the election is made for each member of the group by the parent corporation. The election cannot be revoked without the IRS consent.
The election should state that the company does not want to claim bonus depreciation under IRS Code Section 168(k) either for all qualifying property placed in service during the year or for property in whichever classes you specify. The ending date of the applicable tax year for which you want the election to apply should also be stated.
If you do not want to claim bonus depreciation, it is essential to attach the required statement to the tax return. If you do not claim the deduction and do not make the formal election to that effect, the property will nonetheless be treated as if you had claimed it. When this occurs, the property will never be fully depreciated because before calculating depreciation each year, you must reduce its basis first by the amount of bonus depreciation you did not claim!
Finally, remember that when you claim bonus depreciation on an asset, the deduction is also allowed for Alternative Minimum Tax (AMT) purposes. In fact, any property on which bonus depreciation is claimed is exempt from the AMT depreciation adjustment as the same depreciation as claimed for regular tax purposes is also allowed for AMT purposes. Therefore, if an election is made to forgo the bonus depreciation deduction, such property may be subject to the AMT depreciation adjustment.
2. The date you acquire an asset is not always the date on which depreciation begins.
It’s true: the date you acquire an asset is not necessarily the day on which you can begin depreciating the asset. In order to depreciate any asset, it must first be placed in service.
Although generally it may seem obvious when an asset is placed in service, this is not always the case. To be considered “placed in service,” an asset must be installed, operational, and available for use. So, for example, if rental property is ready to be rented, an actual lease agreement is not necessary to begin depreciating the asset. Once such property is available and ready for rental, depreciation on it can begin. Another example is if an elevator is installed in a new building, it cannot be depreciated before the building itself is placed in service.
To be considered “operational,” an asset must be ready to be operated for the intended purpose for which it was acquired. For example, if a business acquires a forklift for heavy lifting but it must be modified before it can be used to lift a certain desired weight, depreciation cannot begin on it before it is fully able to be used for its intended purpose.
3. Section 179 expense is included as “depreciation” when determining the maximum amount that may be claimed on a luxury vehicle.
We know there are limitations on the amount of depreciation allowed on any luxury vehicle, based on when it is placed in service. You may think that a way to avoid having the limits apply is to claim Section 179 expense on the vehicle. However, if you think this is so, you would be mistaken. “Depreciation” in this case includes any Section 179 expense. Therefore, it would serve no purpose (and, in fact, would put you at a disadvantage as you would be wasting a potential deduction) to claim Section 179 expense on a luxury vehicle.
4. While the midquarter averaging convention usually gives you less depreciation than the half-year convention, any property placed in service in the first half of the year will have more depreciation calculated for it than it otherwise would.
Averaging conventions are the rules for prorating depreciation on assets in the year in which they are placed in service and, also, when disposed (if disposed of before the end of their depreciable lives). For tax reporting purposes, which averaging convention you use is mandated by the IRS and generally is based on the type of property. However, whenever more than 40% of the total depreciable basis of qualifying property is placed in service during the last three months of a tax year, the midquarter averaging convention must be used for all property for which the half-year convention would otherwise be used. The midquarter convention applies to all depreciable property except for nonresidential real and residential rental property (and property both placed in service and disposed of in the same tax year).
The midquarter averaging convention was designed to close a tax loophole where a business could place costly assets in service at the end of a tax year and still receive six months of depreciation on them by using the half-year convention. Now, when such a scenario occurs and the midquarter convention must be used, it usually results in less depreciation being claimed. However, this may not be the case for all property.
Consider this: when using the half year convention, property is allowed six months worth of depreciation regardless of when it is placed in service during the year. On the other hand, with the midquarter convention, property is deemed placed in service at the midpoint of the quarter in which it is placed in service. Therefore, an asset placed in service during the first quarter of a 12-month year, receives one and a half months of depreciation for its placed-in-service quarter plus nine months of depreciation for the rest of the year, giving it ten and a half months of depreciation in total. (Even if placed in service in the second quarter of the year, it would receive seven and a half months of depreciation.) This is a much larger amount than had it used the half-year averaging convention, which would have given the asset only six months of depreciation!
Understanding that the midquarter convention can work to your advantage by maximizing your depreciation deductions at certain times can present you with an opportunity for doing some tax planning. Consider the scenario where most of a company’s newly acquired assets are placed in service in the first six months of the year while close to 40% are placed in service at the end of the year. If this were the case, a small additional purchase of a fixed asset(s) could result in more than 40% of qualifying property being placed in service during the last three months of the year and the midquarter averaging convention would then apply. Therefore, with proper planning you could easily increase the company’s total depreciation expense claimed for the year. Of course, since the midquarter convention is not elective, this only works under limited circumstances.
5. If you acquire a covenant-not-to-compete when purchasing a business, it has a 15-year amortizable life for tax purposes regardless of the actual duration of the contract.
Before IRS Code Section 197 was enacted, most intangible assets were amortized over their determinable useful lives. However, the IRS often disagreed with the lives assigned by taxpayers and frequently ended up going to court over it. Add to this the difficulties taxpayers often encountered when trying to prove that the limited useful life chosen was correct and you can see why something needed to be done. The principal goal of Section 197 was to rid the court dockets of a significant amount of litigation and finally end much of the uncertainty that surrounded the determination of amortizable lives.
Section 197 mandates a 15-year life for certain intangible assets, many of which are acquired when purchasing a trade or business. When Code Section 197 was first introduced, many taxpayers were unhappy to learn that covenants-not-to-compete were included in the mandatory 15-year recovery period. Most covenants-not-to-compete have a much shorter life than 15 years. However, Congress believed that if taxpayers were allowed to write off a covenant-not-to-compete over its actual, but shorter, life, it would provide too great a temptation to overstate the value of the covenant while understating the value of the rest of the acquired assets of the business.
And there you have it; your five fun facts about fixed asset management! Now share your fun facts or send these to a friend.