2011 Auto Depreciation Deduction Limitations - IRS Gives Certain “Luxury Auto” Owners a Break

April 26, 2011
by Rick Taylor, CPA
Tax Services
>
Bookmark and Share

The US tax code is a crazy quilt patchwork of technical provisions that are constantly changing. More and more these provisions have become hidden traps that ensnare unsuspecting taxpayers who are doing their best to comply with their legal obligation to report and pay their taxes. Today’s post discusses just one of the myriad of such “gotch ya” provisions that will impact small business owners and sole proprietors who purchase new automobiles for use in their business after September 8, 2010. 

When Congress enacted the new 100% bonus depreciation provisions, it failed to make conforming changes to the rules that limit depreciation for automobiles (the so-called luxury automobile rules that generally apply to autos costing $15,300 or more). As a result, under the statute taxpayers ordinarily would get to deduct only the first $11,060 of the cost of a new automobile in the year the car is placed in service (i.e., 2010 or 2011) and would get no further depreciation deductions until year seven (assuming the car is around that long). To mitigate this “anomalous result” the IRS has prescribed a safe-harbor method that will permit taxpayers to claim deductions in years two through six (and beyond). Rev. Proc. 2011-26. The safe harbor is included in Rev. Proc. 2011-26, 2011-16 IRB 664 and is done by allowing taxpayers to make a special election in the second year of the car’s life to claim 50%, rather than 100% depreciation. Although it is debatable whether the IRS has the legal authority to change the operation of the statute in this manner, it is doubtful anyone will complain about the provision because it benefits taxpayers. 

One need only consider the time and effort that is going to be spent trying to understand and implement this provision to understand why the United States has slipped so dramatically in terms of productivity.   Unfortunately, if you or your business placed a new automobile in service after September 8, 2010 and before January 1, 2012, you must understand these new rules or you will risk losing valuable depreciation deductions in years two through six. 

Background

Business autos generally are depreciated over five years using the 200% declining balance method, with a built-in switch to straight line. §168(b)(1) and §168(e)(3)(B). Because MACRS depreciation generally treats property as placed in service in the midpoint of the placed-in-service year (and therefore entitled to only a half year of depreciation)  the actual depreciation period is six years. §168(d)(1). Applying the optional table for five-year property, the regular depreciation percentages are 20% for the first year, 32% for the second, 19.2% for the third year, 11.52% for each of the fourth and fifth years, and 5.76% for the sixth year. The percentage is applied to the auto's adjusted depreciable basis in each year of its recovery period. Adjusted depreciable basis is generally equal to cost less the §179 deduction and any amount claimed as bonus depreciation, but unreduced by any amount of regular depreciation.  

Notwithstanding the deduction generated by operation of the MACRs rules discussed above, specific dollar amount limits apply to annual depreciation deductions that may be claimed for “passenger automobiles.” The applicable set of annual dollar amount limits depends on the calendar year in which the vehicle is placed in service. The dollar limits for 2010 are as follows: 

YearPercentageAmount
120%$3,060 **
2 32%$4,900
319.2%$2,950
411.52%$1,775
511.52%$1,775
65.76%$1,775

**  $11,060 if bonus depreciation is claimed.

Allowable depreciation is equal to the lesser of the adjusted depreciable basis times the percentage or the amount for that particular year. So, if the auto’s adjusted depreciable basis is $16,000, allowable depreciation for year one is equal to the lesser of (1) 20% x $16,000 = $3,200 or (2) $3,060. Note, this calculation ignores first-year bonus depreciation. 

The §179 deduction and bonus depreciation are treated as depreciation deductions for the tax year in which a car is placed in service. Thus, the combined §179 deduction, bonus depreciation and regular first-year depreciation deduction is subject to the first year limitation (i.e., $11,060 in 2010). Under §168(k)(2)(F), the applicable first-year depreciation limit is increased by $8,000 for any passenger automobile that is “qualified property” under the bonus depreciation rules. Thus, the enhanced first-year allowance for autos that are qualified property and are bought and placed in service in 2010 or 2011 is $11,060 ($3,060 + $8,000). The dollar limits are slightly higher for light trucks or vans (e.g., first-year cap is $3,160 for vehicles placed in service in 2010, and $3,260 if placed in service in 2011).

The luxury auto dollar limits represent the maximum annual depreciation allowed if there is no personal use of the auto. These amounts must be reduced where the auto is not used 100% for business or investment purposes. See Treasury Regulation §1.280F-2T(b)
 
Because of the application of these luxury auto rules, even when a business auto is used 100% for business, it ordinarily is not fully depreciated when its normal MACRS recovery period ends. If the taxpayer continues using the car for business after the end of the normal recovery period, the taxpayer is entitled to depreciate any unrecovered basis in those subsequent years, subject to a low dollar limitation (i.e., $1,775) until the car is fully depreciated or disposed of §280F(a)(1)(B) and Treasury Regulation §1.280F-2T(c)(4)

For property generally acquired after December 31, 2007, and before September 9, 2010, the bonus depreciation allowance for qualified property is equal to 50% of its unadjusted depreciable basis. Assuming §179 expensing is not claimed, the first-year dollar limitation for an auto that is qualified property and bought and placed in service in 2010, but before September 9, 2010, is determined as follows:

  1. Multiply the auto's adjusted depreciable basis by its business use for the placed-in-service year.
  2. Multiply the result obtained in Line (1) by 50% (bonus depreciation).
  3. Subtract the result obtained in Line (2) from the result obtained in Line (1).
  4. Multiply the result obtained in Line (3) by 20%.
  5. Add the result obtained in Line (4) to the result obtained in Line (2).
  6. Multiply $11,060 by the auto's business/investment use in the placed-in-service year.
  7. The first-year depreciation for the auto is the lesser of Line (5) or Line (6).

EXAMPLE 1:  On January 2, 2010, a calendar-year business purchased and placed in service a new $30,000 auto that it uses 75% for business (with 25% personal use by the owner of the business). It does not expense any part of the auto's cost under §179. The 2010 depreciation deduction for the auto is computed as follows:

  1. $30,000 × .75 business use = $22,500.
  2. $22,500 × .5 = $11,250.
  3. $22,500 − $11,250 = $11,250.
  4. $11,250 × .20 = $2.250.
  5. $11,250 + $2,250 = $13,500.
  6. $11,060 dollar limit × 75% business use = $8,295.
  7. Depreciation deduction for 2010 is $8,295 (lesser of Line (5) or Line (6)).

For 2011, assuming business use continues to be 75%, the depreciation for the auto is the lesser of: (a) ($11,250 × .32 second year table percentage = $3,600, or (b) $3,675 second-year limit (based on the 75% business use percentage). Section 280F(d)(8) provides that for purposes of calculating unrecovered basis in situations where bonus depreciation is claimed, the bonus depreciation deduction should be computed as if business use was 100% in the year the property was placed in service. As a result, second year depreciation without regard to the luxury auto limitation is based on the unrecovered basis reduced by the full bonus depreciation amount and not the dollar limitation actually allowed (i.e., $22,500 - $11,250 bonus depreciation as if business use was 100% = $11,250; $11,250 x .32 = $3,600). Some commercial software applications (including FAS) incorrectly limit the reduction to the amount actually allowed in the first year after application of the luxury auto rules (e.g. $8,295 in the above example) which overstates allowable depreciation by $75 in year two.  

Under the 2010 Tax Relief Act, for property generally acquired and placed in service after September 8, 2010 and before January 1, 2012, the bonus depreciation allowance for qualified property is equal to 100% of its unadjusted depreciable basis. This does not affect the first-year depreciation deduction for a luxury auto. As a result, applying the formula above, but substituting 100% for 50%, yields a maximum first-year deduction of $11,060. However, the problem surfaces in tax years after the placed-in-service year.

Rev Proc 2011-26, 2011-16 IRB 664, provides that if the unadjusted depreciable basis (i.e., basis for gain or loss before depreciation adjustments) of a passenger auto that is qualified property eligible for the 100% additional first-year depreciation deduction exceeds the first-year luxury auto limit, the excess amount is the unrecovered basis of the passenger automobile for purposes of §280F(a)(1)(B)(i);  the unrecovered basis is treated as a deductible expense in the first tax year succeeding the end of the normal five-year (effectively six-year) recovery period subject to the dollar limitation under §280F(a)(1)(B)(ii), which is currently $1,775.

In other words, unless the taxpayer elects out of 100% bonus first-year depreciation, the taxpayer has effectively claimed a 100% first-year depreciation deduction for the vehicle in the first year, even though the bonus depreciation allowance is limited under §168(k)(2)(F). Thus, applying the normal business-auto depreciation rules for years two through six yields a zero deduction.

To mitigate this “anomalous result,” Section 3.03(5)(c)(ii) of Rev. Proc. 2011-21 permits the business auto owner to make an election to be deemed to have claimed 50% (and not 100%) bonus depreciation for every cost-recovery purpose other than computing the first-year's writeoff. This elective “safe harbor method of accounting” solution applies where a passenger auto: (a) has unadjusted depreciable basis in excess of the first-year luxury auto limit ($11,060 for autos for 2010 or 2011, or for light trucks or vans, $11,160 for 2010 and $11,260 for 2011); and (2) is qualified property eligible for 100% bonus first-year depreciation (i.e., is new property placed in service by the taxpayer after September 8, 2010, and before January 1, 2012). Thus, as a practical matter, the IRS's safe-harbor solution applies to virtually all autos, light trucks and vans.

The application of the safe harbor method of accounting for vehicles other than those with a low cost is as follows:

  1. In the placed-in-service year, the taxpayer deducts the lesser of 100% additional first-year depreciation for the auto or the first-year luxury auto limit ($11,060 for autos, $11,260 for light trucks or vans).
  2. The taxpayer determines the auto's unrecovered basis for the first (placed-in-service) year as if he had claimed 50%, rather than 100%, additional first-year depreciation. For this purpose, unrecovered basis is equal to the depreciation that would be allowable had the taxpayer claimed 50% bonus first-year depreciation less the amount determined under Step (1), above.
  3. If there is any unrecovered basis for the passenger automobile in its placed-in-service year (as determined in Step (2)), the taxpayer determines the auto's depreciation deductions for the tax years after the placed-in-service year as if the taxpayer claimed 50%, rather than 100%, bonus first-year depreciation for the auto, subject to the applicable luxury-auto dollar limits. As a result, for purposes of Reg. § 1.168(k)-1(d)(2) (relating to otherwise allowable depreciation deductions after bonus depreciation is claimed), the auto's remaining adjusted depreciable basis equals its unadjusted depreciable basis reduced by the amount of the 50% bonus first-year depreciation deemed allowed or allowable, whichever is greater.

EXAMPLE 2:  In October 2010, a calendar-year taxpayer bought and placed in service a new $30,000 passenger auto that is used 75% for business and is eligible for 100% bonus first-year depreciation. A §179 deduction is not claimed and the taxpayer elects to use the safe harbor method of accounting provided by Section 3.03(5)(c)(ii) of Rev. Proc. 2011-2. Annual depreciation is calculated as follows:

  1. For 2010, the taxpayer deducts $8,295 ($11,060 x 75% business use = $8,295.  
  2. For purposes of determining unrecovered basis, total depreciation allowable for 2010 is deemed to be $13,500; [$30,000 x .75 business use x .50 bonus depreciation = $11,250] + [$11,250 x .20 first year table amount = $2,250]. Thus, the unrecovered basis for the passenger automobile for 2010 is $5,205 ($13,500 deemed depreciation allowable less the $8,295 actual depreciation deduction claimed for 2010), and that amount is recovered by the taxpayer beginning in the 2016 tax year, subject to the $1,331 (1,775 x .75 business use percentage) dollar limit for that year. Since the depreciation is not further limited during any of the other years in the recovery period, the unrecovered basis that is recovered after the end of the normal recovery period remains $5,205. If the depreciation was limited in years two through six, then the unrecovered basis would increase by the business use percentage of the limited amount. See example using a cost of $40,000 below. Note that even though business use was only 75%, the unrecovered basis is reduced by 100% of the bonus depreciation as required by §280F(d)(8). 
  3. For 2011, the taxpayer’s total depreciation is deemed to be $3,600 ($11,250 remaining adjusted depreciable basis x .32 second year table percentage). Because this amount is less than the second-year depreciation limitation of $3,675 ($4,900 x .75 business use percentage), the taxpayer deducts $3,600 as depreciation on its return for the 2011 tax year.
  4. For 2012, the taxpayer’s total depreciation is deemed to be $2,160 ($11,250 x .192 third year table percentage). Because this amount is less than the third-year depreciation limitation of $2,213 ($2,950 x .75 business use percentage), the taxpayer deducts $2,160 as depreciation on its return for the 2012 tax year.  
  5. For 2013 and 2014, the taxpayer’s total depreciation is deemed to be $1,296 ($11,250 x .1152).  Because this amount is less than the fourth and fifth-year depreciation limitation of $1,331 ($1,775 x .75 business use percentage), the taxpayer deducts $1,296 on its 2013 and 2014 tax return. 
  6. For 2015, the taxpayer’s total depreciation is deemed to be $648 ($11,250 x .0576). Because this amount is less than the fourth and fifth-year depreciation limitation of $1,331 ($1,775 x .75 business use percentage), the taxpayer deducts $648 on its return for the 2015 tax year.  
  7. Because the luxury auto limitations applied during the normal recovery period, there remains $5,205 of unrecovered basis that can be recovered at a rate of $1,331 per year during 2016, 2017 and 2018, with a final deduction of $1,211 in 2019. 
  8. This example is based on Rev Proc 2011-26, Sec. 3.04, Example 5. 

A taxpayer makes the safe-harbor election to use the safe-harbor method of accounting for autos by adopting it to compute depreciation on its return for the first tax year following the auto's placed-in-service year.

The safe-harbor method of accounting also is complex if the auto is lower-priced, (i.e., where the depreciation deduction using a 50% deemed first-year depreciation allowance is less than the luxury-auto dollar-limit for bonus-depreciation-eligible vehicles).

EXAMPLE 3:  In October 2010, a calendar-year taxpayer bought and placed in service a new $18,400 passenger auto that is used 75% for business and is eligible for 100% bonus first-year depreciation. A §179 deduction is not claimed and the taxpayer elects to use the safe harbor method of accounting provided by Section 3.03(5)(c)(ii) of Rev. Proc. 2011-2. Annual depreciation is calculated as follows:

  1. For 2010, the taxpayer deducts $8,295, which is $11,060 x 75% business use = $8,295. 
  2. Under the safe harbor method of account, the taxpayer is deemed to have claimed the 50% additional first year depreciation deduction for purposes of determining the unrecovered basis and the remaining adjusted depreciable basis of the passenger automobile. As a result, for 2010, the total allowable depreciation is deemed to be $8,280 [$18,400 x .75 business use x .50 bonus depreciation = $6,900] + [$6,900 x .20 first year table amount = $1,380]. Thus, there is no unrecovered basis for the auto for 2010 because the 2010 deemed depreciable allowable of $8,280 is less than the 2010 depreciation deduction of $8,295.
  3. Pursuant to section 3.03(5)(c)(ii)(D) of Rev. Proc. 2011-21, the taxpayer must not use the optional depreciation tables for computing the depreciation deductions for the passenger auto for taxable years subsequent to the placed-in-service year. Therefore, assuming the applicable depreciation method and convention for the auto is 200% declining balance, the total depreciation allowable for 2011 is $2,202 (.4 *($18,400 x .75 business use - $8,295). Because this amount is less than the depreciation limitation of $3,675 ($4,900 x .75), the taxpayer deducts $2,202 on its federal income tax return for the 2011 tax year.
  4. The total depreciation allowable for 2012 is $1,321 (.4*($18,400 x .75 business use - $8,295 - $2,202). Because this amount is less than the depreciation limitation of $2,213 ($2,950 x .75 business use), the taxpayer deducts $1,321 on its federal income tax return for the 2011 tax year. 
  5. The switch to straight line occurs generally at the mid-point in the asset’s life. In this case, the switch occurs for purposes of calculating 2013 depreciation. At this point, there is 2 ½ years left in the recovery period. So the depreciation rate remains at 40% (1/2.5 = 40%). The total depreciation allowable for 2013 is $793 (.4*($18,400 x .75 business use - $8,295 - $2,202 - $1,321). Because this amount is less than the depreciation limitation of $1,331 ($1,775 x .75 business use), the taxpayer deducts $793 on its federal income tax return for 2013.
  6. The total depreciation allowable for 2014 is $793 (.6667*($18,400 x .75 business use - $8,295 - $2,202 - $1,321 - $793). Because this amount is less than the depreciation limitation of $1,331 ($1,775 x .75 business use), the taxpayer deducts $793 on its federal income tax return for 2014.
  7. Finally, the total depreciation allowable for 2015 is $396 ($18,400 x .75 - $8,295 - $2,202 - $1,321 - $793 - $793). Because this amount is less than the depreciation limitation of $1,331 ($1,775 x .75 business use), the taxpayer deducts $396 on its federal income tax return for 2015. At this point, the business use portion of the asset is fully depreciated. 
  8. This example is based on Rev Proc 2011-26, Sec. 3.04, Example 6. 

A taxpayer that places in service qualified (i.e., bonus-depreciation-eligible) property in a tax year that includes September 9, 2010, can make an actual election (as opposed to a deemed election), to “step down” from 100% to 50% bonus depreciation for assets in a particular class. If the actual election is made for five-year MACRS property, it will generally yield the same depreciation results for a new, non-low-priced passenger auto as the deemed election. However, the disadvantage of making the step down election is that it applies to all assets in that class placed in service in the year for which the election is made.

If you are contemplating the purchase of a larger vehicle, one way to entirely avoid potential headaches associated with the 100% first-year bonus depreciation rules and the luxury auto rules is to buy a vehicle with a gross vehicle weight rating of more than 6,000 pounds. The limited-time 100% bonus depreciation allowance for qualified property under §168(k) allows you to buy a new heavy SUV and use it entirely for business to write off the entire purchase price in the placed-in-service year. See my post on this topic dated December 21, 2010

An additional way to largely avoid the issues highlighted here is to lease business autos instead of purchasing them. The entire business use percentage of the lease cost, net of a generally modest lease income inclusion amount from an IRS table, will be deductible.

The following charts provide additional illustration of the calculations discussed above. They are presented here without further discussion because the concepts are discussed above. If you have questions or comments, or you believe that I have made errors in my calculations, please provide feedback including your alternative calculations.

The difficulty involved in making these calculations perfectly demonstrates why our tax code is irretrievably broken. The cost of complying with these rules is beyond what should be requested in a civilized society. 

Original Cost

$40,000

 

 

 

 

 

 

Bonus Depreciation

50%

$20,000

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Normal

 

MACRS

Unrecovered

MACRS

Unrecovered

 

 

 

MACRS

Luxury

Allowed

Basis

if

Basis

 

Table 1

Normal

with

Auto

if

if

75%

if

 

Amounts

MACRS

Bonus

Limits

100%

100%

Business

75%

2010

0.2

8,000

24,000

11,060

11,060

28,940

8,295

21,705

2011

0.32

12,800

6,400

4,900

4,900

24,040

3,675

18,030

2012

0.192

7,680

3,840

2,950

2,950

21,090

2,213

15,818

2013

0.1152

4,608

2,304

1,775

1,775

19,315

1,331

14,486

2014

0.1152

4,608

2,304

1,775

1,775

17,540

1,331

13,155

2015

0.0576

2,304

1,152

1,775

1,152

16,388

864

12,291

2016

 

 

 

1,775

1,775

14,613

1,331

10,960

2017

 

 

 

1,775

1,775

12,838

1,331

9,629

2018

 

 

 

1,775

1,775

11,063

1,331

8,297

2019

 

 

 

1,775

1,775

9,288

1,331

6,966

2020

 

 

 

1,775

1,775

7,513

1,331

5,635

2021

 

 

 

1,775

1,775

5,738

1,331

4,304

2022

 

 

 

1,775

1,775

3,963

1,331

2,972

2023

 

 

 

1,775

1,775

2,188

1,331

1,641

2024

 

 

 

1,775

1,775

413

1,331

310

2025

 

 

 

1,775

413

0

310

0

2026

 

 

 

 

 

 

 

 

2027

 

 

 

 

 

 

 

 

 

1.0000

$40,000

$40,000

 

$40,000

 

$30,000

 

 

 

 

 

 

 

 

 

 

 

Original Cost

$30,000

 

 

 

 

 

 

Bonus Depreciation

50%

$15,000

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Normal

 

MACRS

Unrecovered

MACRS

Unrecovered

 

 

 

MACRS

Luxury

Allowed

Basis

if

Basis

 

Table 1

Normal

with

Auto

if

if

75%

if

 

Amounts

MACRS

Bonus

Limits

100%

100%

Business

75%

2010

0.2

6,000

18,000

11,060

11,060

18,940

8,295

14,205

2011

0.32

9,600

4,800

4,900

4,800

14,140

3,600

10,605

2012

0.192

5,760

2,880

2,950

2,880

11,260

2,160

8,445

2013

0.1152

3,456

1,728

1,775

1,728

9,532

1,296

7,149

2014

0.1152

3,456

1,728

1,775

1,728

7,804

1,296

5,853

2015

0.0576

1,728

864

1,775

864

6,940

648

5,205

2016

 

 

 

1,775

1,775

5,165

1,331

3,874

2017

 

 

 

1,775

1,775

3,390

1,331

2,543

2018

 

 

 

1,775

1,775

1,615

1,331

1,211

2019

 

 

 

1,775

1,615

0

1,211

0

 

 

 

 

 

 

 

 

 

 

1.0000

$30,000

$30,000

 

$30,000

 

$22,500

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Original Cost

$18,400

 

 

 

 

 

 

Bonus Depreciation

50%

$9,200

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Double

 

Normal

 

MACRS

Unrecovered

MACRS

Unrecovered

 

Declining

 

MACRS

Luxury

Allowed

Basis

if

Basis

 

Balance

Normal

with

Auto

if

if

75%

if

 

Amounts

MACRS

Bonus

Limits

100%

100%

Business

75%

2010

0.4

7,360

11,060

11,060

11,060

7,340

8,295

5,505

2011

0.4

4,416

2,936

4,900

2,936

4,404

2,202

3,303

2012

0.4

2,650

1,762

2,950

1,762

2,642

1,321

1,982

2013

0.4

1,590

1,057

1,775

1,057

1,585

793

1,189

2014

0.66667

1,590

1,057

1,775

1,057

528

793

396

2015

1

795

528

1,775

528

0

396

0

2016

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

3.2667

$18,400

$18,400

 

$18,400

 

$13,800

 


 

Comments