The “Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010” (2010 Tax Relief Act) includes a number of business benefits designed to stimulate the economy. One obscure and perhaps unintended benefit is a provision that permits purchasers of new large SUVs to expense the entire cost of the SUV in the year it is placed in service. Extra benefit may be generated if the business purchases the SUV with a trade-in involving an automobile that is subject to the luxury automobile rules. This post points out how you (sole proprietorship) or your business (partnership, LLC, S corporation or C corporation) can qualify for this valuable benefit; but be careful, because the rules are tricky and you must to careful to meet the strict provisions of law.
Luxury Automobile Rules
Four-wheeled vehicles having an unloaded gross weight of 6,000 pounds or less that are manufactured primarily for use on public roads are referred to as passenger automobiles and are subject to depreciation limitations (i.e., the “luxury automobile rules”) under §280F(d)(5). Under the luxury automobile rules applicable to cars, you and/or your business are limited to specific annual deduction ceilings. These ceilings, which are indexed for inflation, operate to extend depreciation beyond the sixth year for cars costing more than what the total depreciation allowance would be over the six years. For cars first put in service in 2010, the ceiling is $11,060 for 2010; the annual ceiling amount for 2011, is $4,900; the annual ceiling amount for 2012, is $2,950; and the annual ceiling amount for later years is $1,775. Slightly higher ceiling amounts apply for certain light trucks and vans (passenger autos built on a truck chassis, including minivans and light SUVs) first placed in service in 2010.
You and/or your business cannot avoid these limitations by making an election to “expense” the car (§179 election). Although §179 expensing can be claimed on luxury autos, such amount is limited to the luxury automobile ceiling amount. If the car is used partly for business purposes and partly for personal purposes, the limits are reduced to the business percentage. For example, the maximum depreciation deduction for a car first placed in service in 2010 and used 75% for business is $8,295 (75% of $11,060) for the first year. The “personal” 25% portion ($2,765) is disallowed.
Exception to the Luxury Automobile Rules
Four-wheeled vehicles (e.g., SUVs) with gross vehicle weights in excess of 6,000 pounds are not subject to the luxury auto rules. Several of the popular sport utility vehicles (e.g., Cadillac Escalades, Chevrolet Suburbans, Toyota Land Cruisers, etc.) are heavy enough to be rated for gross vehicle weight in excess of 6,000 pounds. Some common websites, such as www.intellichoice.com and www.carsdirect.com/research/, can be used to look up a vehicle's weight.
Vehicle that are not subject to the luxury auto rules can be depreciated using 50%/100% bonus depreciation; §179 expensing of vehicles with a gross vehicle weight in excess of 6,000 pounds, but not more than 14,000 pounds is generally limited to $25,000 unless the vehicle is a heavy pick-up truck, 9 passenger van or other special use vehicle. Bonus depreciation and §179 expensing can be claimed only if the qualified business use test is met in the year the property is acquired. If the qualified business use does not exceed 50%, depreciation must be calculated using the straight-line method over a five-year period (known as straight-line ADS), and the §179 deduction cannot be taken. As a result, otherwise qualified vehicles that are used 50% or less for business are not eligible for the higher first-year §280F depreciation limit since straight-line ADS depreciation is required for such property under §280F(b)(1).
For the 50% business use test, only qualified business use is counted (i.e., use in a trade or business). It does not include use in an investment activity or other activity conducted for the production of income (i.e., rental). Thus, for purposes of the more than 50% business use test, rental or compensated use by a 5% owner is not counted toward the 50% business use test. However, once the more than 50% threshold is met, rental or compensated use to a 5% owner IS considered for determining the percent of the total allowable depreciation that can be claimed. Thus, if your business use of the SUV without regard to your personal use is 51% of the total use of the SUV in the year it is placed in service and if you reimburse the business for your personal use (or the business treats such personal use as additional compensation which is taxable to you), the SUV will qualify for 100% bonus depreciation if the SUV is placed in service after September 8, 2010 and before January 1, 2012.
If the qualified business use percentage is greater than 50% in the first year, but thereafter falls to 50% or less, you and/or your business must recapture the excess depreciation as ordinary income. The recapture rules include conversion of the SUV to 100% personal use. Excess depreciation is the excess of §179 and other depreciation deductions allowed in years that the vehicle's business use exceeded 50% over the depreciation that would have been allowed in those years using SL depreciation over a five-year recovery period.
50% bonus depreciation applies to qualifying property placed in service after 2007 and before September 9, 2010. Qualifying property placed in service after September 8, 2010 and before January 1, 2012, is subject to 100% bonus depreciation. The definition of “qualifying property” is the same for 50% and 100% bonus depreciation purposes.
Example - Sport utility vehicle acquired after September 8, 2010.
On December 21, 2010, S Corp spends $70,000 for a 2011 Escalade. The Escalade is considered used 100% in S Corp’s business because the business owner’s personal use is 49% or less of total use and the personal use is treated as additional compensation to the business owner. The Escalade is not a passenger automobile since its maximum loaded weight, based on information from the manufacturer, is over 6,000 pounds (7,200 pounds according to http://www.carsdirect.com/research/specs?cat=6&make=CA&modelid=662&acode=USC10CAS021A0&year=2011). Therefore, it is not subject to the Section 280F limits. The vehicle qualifies for first-year bonus depreciation equal to 100% of its cost or $70,000. Alternatively, S Corp could elect to deduct up to $25,000 of the cost under §179 and the balance of $45,000 as bonus depreciation. The reason for taking this approach is to accelerate deductions for state purposes since bonus depreciation typically is not allowed for state purposes (e.g., it is not allowed for Wisconsin purposes), but the section 179 deduction is allowed – although limited to $25,000 which was the amount formerly allowed for Federal purposes.
Because Wisconsin has not conformed to the federal changes to §179 that began in 2003, the maximum expense election limit is $25,000, subject to reduction as a qualifying investment exceeds $200,000. Wisconsin does not recognize bonus depreciation. Minnesota is similar to Wisconsin in that it permits a $25,000 §179 deduction, subject to reduction as a qualifying investment exceeds $200,000. Minnesota requires that 80% of first year bonus depreciation be added back and deducted evenly over the next five years. Illinois has an adjustment for bonus depreciation, but not for §179. The “mix” of bonus depreciation to §179 deduction generally depends on what will give the best state result.
Bonus Deprecation Applies to Entire Adjusted Basis (including trade-in)
It is important to note that bonus depreciation is available for new, original use assets only, whereas §179 may be claimed for new and used assets. More importantly, 50% bonus depreciation applies to the entire adjusted tax basis of a new asset, whereas §179 may be claimed only on the boot in connection with a trade or business. This is important because if you and/or your business have been subject to the luxury automobile rules in the past, you have undoubtedly accumulated a significant un-depreciated adjusted basis in automobiles used in the business. This additional basis is subject to the luxury automobile limitations which causes the depreciation attributable to that basis to be deferred indefinitely (because the luxury automobile ceiling limits prevent the deduction of the adjusted basis during the automobile’s useful life). However, if the luxury automobile is traded in on an SUV that exceeds the 6,000 weight limit, the full adjusted basis can be deducted under the bonus depreciation rules subject to the limitations discussed above (i.e., placed in service after September 8, 2010 and before January 1, 2012, new, original use property, 100% business use).
Keys to Success
The rules governing this benefit are tricky and it is easy to slip up. As a result, it is important that you consult with a qualified tax advisor to ensure there are no missteps. In addition, keep in mind these key requirements:
- The SUV must have a gross vehicle weight in excess of 6,000.
- The SUV must be purchase new and you and/or your business must be the original owner.
- The SUV must be purchase after September 8, 2010, and before January 1, 2012.
- The qualified business use of the SUV must exceed 50% of the total use of the vehicle in the year it is placed in service not counting any personal or compensated use of the SUV by the owner of the business.
- If the more than 50% qualified business use test is met, the use of the SUV including compensated use of the vehicle by the owner of the business or other employees in included in determining the total business use percentage.
- Adequate documentation must be maintained throughout the year (and not just recreated at the end of the year or when and if the IRS audits) to prove the claimed qualified business use.
- If you cannot purchase your new business SUV before the end of this year, you still have until the end of 2011 to get these valuable benefits.