Extension of Bonus First-year Depreciation

In most cases, taxpayers must recover the cost of assets used in a trade or business or for the production of income through annual depreciation deductions on their tax returns. Deductions must be spread out whether the taxpayer pays cash or finances the purchase.

The amount of the annual depreciation deduction is usually determined using a series of rules called the modified accelerated cost recovery system (MACRS). To figure the deduction for a particular item, one must know not only the property’s cost, but also the recovery period, depreciation method, and placed in service convention applicable to the type of property under MACRS. Various IRS regulations and procedures spell out the rules.

Example: Company X buys a delivery truck for $50,000 in 2004. Under MACRS, general-purpose trucks belong in the five-year recovery class. Using the 200% declining balance method and a half-year convention, Company X’s first-year depreciation is 20% (200% divided by 5 divided by 2) of $50,000 – or $10,000.

In 2002, a new law gave businesses an opportunity to significantly increase their first-year depreciation deductions. The goal was to provide businesses with tax savings that might be used to help finance the purchases of the assets themselves or to meet other business objectives.

The 2002 law introduced, for a limited time, an additional first-year depreciation “bonus” equal to 30% of the adjusted basis (essentially, cost) of qualified property. To qualify under the 2002 law, the property must generally be new property acquired after September 10, 2001, and before September 11, 2004, and that is placed in service before January 1, 2005. In addition, the property must be:

The bonus depreciation is available for both regular and alternative minimum tax purposes, is not mandatory, and doesn’t preclude the regular deduction for first-year depreciation. However, the bonus depreciation is subtracted from the property’s adjusted basis when figuring the regular deduction.

The 2003 Act expands and modifies the bonus depreciation provisions. Under the new law, taxpayers can elect additional first-year depreciation of 50% for qualified property. Qualified property is defined in the same manner, as under the 2002 law except the time period for acquisition is different. The original use of the property must commence with the taxpayer after May 5, 2003, and the property must be acquired by the taxpayer after May 5, 2003, and before January 1, 2005, and be placed in service before that latter date. Again, other requirements and exceptions apply.

Example: Returning to our earlier example, assume Company X qualifies for the additional 50% first-year depreciation deduction for the $50,000 truck. Instead of claiming the regular depreciation deduction of $10,000, Company X may claim three times that amount in 2004 -$30,000. That amount consists of $25,000 of additional first-year depreciation (50% times $50,000) plus $5,000 of regular MACRS depreciation (20$ of $25,000, the truck’s remaining basis after subtracting the $25,000 of bonus depreciation).

Other related provisions of the 2003 Act include: