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The maximum amount of business equipment that can be expensed each year is subject to a ceiling amount. The ceiling amount is $125,000 in 2007 ($128,000 in 2008 and indexed further for inflation in later years).
If the cost of qualified property placed in service by a business during the year is more than $500,000 in 2007 ($510,000 in 2008 and indexed for inflation in later years), the ceiling for that business is reduced by the amount over the applicable limit. This limit is intended to keep the expensing election targeted toward small businesses.
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Example
In 2007, Bobscarts, Inc., a company that manufactures electric golf carts, purchases for $538,000 a machine to be used in its business. Bobscarts would be able to expense $87,000 of the cost of the machine ($125,000 - [$538,000 - $500,000]).
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Empowerment zone businesses. If substantially all of the property's use is in a trade or business located in an empowerment zone, the annual deduction limit is increased an additional $35,000 (e.g., $160,000 in 2007 and $163,000 in 2008). Some special requirements will apply, so consult your tax advisor or IRS Publication 946, How To Depreciate Property, if you think this higher limit might apply to you.
What if your new equipment exceeds the limit? If you purchase equipment that exceeds the dollar limit, you can depreciate the excess amount under the usual rules.
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Example
Say that you purchased a full suite of office furniture and equipment for
$133,000 in early 2007, and this was your only capital expense for the year. You could expense $125,000 of the cost in 2007, which would leave a remaining balance of $8,000. You could then depreciate the $8,000 over seven years, yielding a 2007 depreciation deduction of $1,142.86.
Your total write-off for the furniture in 2007 would be $125,000 + $1,142.86 = $126,142.86.
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If your equipment purchases for the year exceed the expensing dollar limit, you can decide to split your expensing election among the new assets any way you choose. Generally speaking, where you have a choice, it's best to expense those assets with the longest depreciation periods (e.g., seven-year property), so you can claim a quicker write-off for them. If the asset has a shorter depreciation period (e.g., three-year property), expensing it in the first year is not going to make as much of a difference.
Special rules for cars. For many small business owners, the only time they would even approach the $125,000 limit would be the year they purchase a new car. But as fate would have it, there is a special rule that prevents you from deducting the full price of the car. Generally, for cars, the amount that may be expensed the first year under this election is limited to $3,060 for vehicles placed in service in 2007 (this amount is adjusted periodically due to inflation).
Special rules for SUVs. A well-publicized tax break once allowed taxpayers who purchased a truck or van with a gross vehicle weight rating (GVWR) in excess of 6,000 pounds to deduct more than $100,000 of the vehicle's cost in the year of purchase assuming that the vehicle is used 100 percent for business purposes. A sport utility vehicle (SUV) built on a truck chassis would qualify for this purpose.
However, the American Jobs Creation Act of 2004 limits the cost of an SUV that may be expensed in the first year to $25,000. The reduced limit applies to vehicles placed in service after October 22, 2004.
Although this infamous tax loophole is smaller, the new law does not eliminate the exemption from the luxury car depreciation limitations for SUVs that have a GVWR in excess of 6,000 pounds. It simply prevents a taxpayer from expensing the maximum amount otherwise allowable under the expensing election (which would have been $105,000 in 2005 without the law change).
Owners of heavy SUVs will still be able to claim a significantly higher first-year depreciation deduction than owners of lighter vehicles. A taxpayer may also still purchase a pick-up truck with a GVWR in excess of 6,000 pounds and expense the entire cost, assuming 100 percent business use.
In addition, the term "sport utility vehicle" and, thus, the new $25,000 limit, does not apply to any vehicle that:
- is designed to have a seating capacity of more than nine persons behind the driver's seat,
- is equipped with a cargo area of at least six feet in interior length which is an open area or is designed for use as an open area but is enclosed by a cap and is not readily accessible directly from the passenger compartment, or
- has an integral enclosure, fully enclosing the driver compartment and load carrying device, does not have seating rearward of the driver's seat, and has no body section protruding more than 30 inches ahead of the leading edge of the windshield.
Increased deductions for Hurricane Katrina replacement property. The Gulf Opportunity Zone Act of 2005 increases the expensing limitation by the lesser of $100,000, or the cost of qualified Code Sec. 179 Katrina Go Zone property. It also increases the investment limitation by the lesser of $600,000, or the cost of qualified Code Sec. 179 Katrina GO Zone property placed in service during the tax year. Property purchased on or after August 28, 2005, and placed in service on or before December 31, 2007, qualifies.
The Small Business and Work Opportunity Tax Act extends the availability of the increased expensing election deduction for qualified Gulf Opportunity Zone property has been extended for an additional year, so that the increased deduction may be taken with respect to property placed in service in tax years beginning in 2008. However, the extension only applies for property "substantially all of the use of which is in one or more specified portions of the GO Zone." The specified portions of the GO Zone are those counties or parishes in which the 2005 hurricanes damaged more than 60 percent of the occupied housing units. These are the Louisiana parishes of Calcasieu, Cameron, Orleans, Plaquemines, St. Bernard, St. Tammany, and Washington, and the Mississippi counties of Hancock, Harrison, Jackson, Pearl River, and Stone.
Although the basic expensing election limit is indexed each year for inflation (e.g., $125,000 in 2007), the additional Katrina GO Zone limit is not indexed for inflation. This makes the total expensing for 2007 GO investments limited to $225,000. Likewise, only the regular phase-out threshold on the acquisition of qualified property is indexed ($500,000 in 2007). Therefore, the total GO Zone cap is $1.1 million in 2007 for Katrina-related expenditures. Also, a taxpayer may place up to $1,325,000 of section 179 Gulf Opportunity Zone property in service in 2006 before complete phase-out under the investment limitation rule ($225,000 - ($1,325,000 - ($500,000 + $600,000)) = $0).
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Warning
For the increased limits to apply, the property must be both section 179 property and qualified Gulf Opportunity Zone property. To qualify as section 179 property, the property must be new or used tangible property that is depreciable under MACRS (subject to an exception for off-the-shelf computer software) and used predominantly (more than 50 percent) in the active conduct of a trade or business. In addition, the property must be acquired by "purchase" from an unrelated person.
Certain qualified Gulf Opportunity Zone property, most notably, residential rental and nonresidential real property and certain used property will not qualify for the increased allowance because it is not also section 179 property.
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In addition, the new law allows a taxpayer to claim a 50-percent additional depreciation allowance on new business property placed in service in the Gulf Opportunity Zone on or after August 28, 2005, and before January 1, 2008 (January 1, 2009 in the case of residential rental and nonresidential real property).
Qualified Katrina GO Zone property means:
- depreciable MACRS recovery property with a recovery period of 20 years or less, MACRS water utility property, qualified leasehold improvement property, off-the-shelf computer software, residential rental property, or nonresidential real property;
- substantially all use of the property must be in the active conduct of a trade or business by the taxpayer within the Gulf Opportunity Zone (i.e., that portion of the Hurricane Katrina disaster area determined by the President to warrant individual or individual and public assistance from the federal government under the Stafford Act by reason of Hurricane Katrina);
- the original use of the property in the Gulf Opportunity Zone must commence with the taxpayer on or after August 28, 2005;
- the property must be acquired by purchase;
- no written binding contract for the acquisition of the property may be in effect before August 28, 2005;
- the property must be placed in service on or before December 31, 2007 (December 31, 2008 in the case of nonresidential real property and residential rental property).
As a result of some controversy, Gulf Opportunity Zone property does not include property used in connection with:
- a private or commercial golf course,
- a country club,
- a massage parlor,
- a hot tub facility,
- a suntan facility,
- a liquor store, or
- a gambling or animal racing property.
Coordinating all the possible deductions can be tricky, as the examples below illustrates. This is one of those areas that require some form of professional tax help to successfully navigate through.
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Example
In 2007, a calendar-year taxpayer places in service $200,000 of qualified Gulf Opportunity Zone property and $520,000 of other property qualified for the expensing election. The dollar limitation is $225,000 ($125,000 + $100,000). The investment limitation is $700,000 ($500,000 basic limit + $200,000 amount of qualified Gulf Opportunity Zone property placed in service since this is less than $600,000). Because the total amount of property placed in service ($720,000) exceeds the investment limit by $20,000 ($720,000 - $700,000), the dollar limit is reduced to $205,000 ($225,000 - $20,000) and this amount is claimed as the deduction under the expensing election subject to the taxable income limitation.
The taxpayer may also claim an additional first-year depreciation allowance equal to 50 percent of the adjusted basis of the Gulf Opportunity Zone property and a regular first-year MACRS depreciation deduction. The adjusted basis is its cost less the amount of the property expensed under the expensing election.
Regular MACRS deductions are computed on the cost as reduced by the expense deduction and the additional first-year depreciation deduction.
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Example
XYZ corporation, a calendar-year taxpayer, places $1,170,000 of new machinery in service in 2007. The machinery is qualified section 179 Gulf Opportunity Zone property. XYZ places no other section 179 property in service in 2007. Under the dollar limitation, only $225,000 ($125,000 basic limit + $100,000 bump-up for section 179 Gulf Opportunity Zone property) of the total $1.17 million of machinery placed in service may be expensed. The investment limit is $1,100,000 ($500,000 basic limit + $600,000 maximum increase since this is less than the cost of qualifying section 179 zone property placed in service). The dollar limit must be reduced by $70,000 ($1,170,000 cost of section 179 property placed in service - $1,100,000 investment limit). Thus, XYZ's section 179 deduction for 2007 is $155,000 ($225,000 dollar limit - $70,000), assuming that XYZ's taxable income is at least $155,000.
XYZ's 50-percent additional depreciation allowance is $507,500 ($1,170,000 - $155,000) X 50%).
XYZ's regular first-year MACRS depreciation deduction, assuming that the machinery is 5-year property and that the half-year convention applies, is $101,500 ($1,170,000 - $155,000 - $507,500) X 20% first-year MACRS table percentage).
XYZ's total first year write-off for the $1.17 million of new machinery in 2007 would be $764,000 ($155,000 expensing amount + $507,500 bonus depreciation + $101,500 regular depreciation).
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