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IRS release solves 'second year zero' problem for auto depreciation

March 30, 2011

The IRS yesterday issued eagerly-awaited guidance on bonus depreciation (Rev. Proc. 2011-26). Key bits:

- You will be able to elect 50% bonus depreciation, rather than 100%, for assets qualifying for the 100% bonus -- but only for the tax year that includes September 9, 2010.

- It confirms that projects started as late as January 1, 2008 can qualify for 100% bonus depreciation, if placed in service between September 9, 2010 and December 31, 2011. This will be good news for farmers with new building going into service after last September 8.

- The IRS provided a "safe harbor" that solves the "zero second year depreciation" problem for cars subject to 100% bonus depreciation.

"Bonus" depreciation allows you to deduct an extra part of a fixed asset in the year it is placed in service. The part of property not qualifying for bonus depreciation is recovered over a period of years, usually five or seven years. With "50% bonus" depreciation, you deduct half of the cost in the year you place an asset into service, and you deduct the remaining cost under the usual depreciation rules. With "100% bonus," the entire cost is deducted in the first year.

20110330-1.jpg
A new 2011 Ford Fiesta listed for $16,977 at Stivers Ford Lincoln Mercury. This car can qualify for 100% bonus depreciation, subject to the "luxury auto" limits.


With cars, it's more complicated. The so-called "luxury auto" rules limit annual depreciation of cars. The limit is adjusted annually for inflation. It kicks in for cars costing around $15,300 and up (you can find the current limits here). As a nod to bonus depreciation, the first-year "Sec. 280F" limit was increased to $11,060 for 2010 and 2011.

A technical reading of the luxury auto rules says that if you take "100% bonus" depreciation for a car, you get the $11,060 in year 1, but then you get no more depreciation until year 7. The new IRS safe harbor allows taxpayers to make a special computation that allows them to take depreciation in years 2-6 also, up to the usual annual Sec. 280F limits. The safe harbor computations are confusing, but the bottom line of thenew guidance is that you get full 280F-limited depreciation starting in year 2 for cars with costs starting around $18,450. The computation for cars costing less than that is more puzzling, but you do get year 2-6 depreciation. (Cars are "five year" property, but because the car is normally considered to be placed in service at the mid-point of the year, the depreciable life goes into a sixth year).

While welcome, the "luxury auto" safe harbor seems like a long way to get home. The IRS apparently agreed with the "second year zero" reading of the tax law. Rather than ignoring the implied Congressional malpractice, IRS made up a whole new funky depreciation rule to get around the problem. While it's hard to see where the Code says they can do that, nobody is likely to complain.

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