Combining New Tax Breaks for Business Property

The new tax legislation passed by Congress earlier this year—officially titled the Economic Stimulus Act of 2008—provides a unique opportunity for businesses of all sizes. Under the new act, a business such as a construction firm can combine enhanced Section 179 “expensing” with “bonus depreciation deductions” for property placed in service in 2008.

Due to this tax break, it may be possible to write off most, if not all, of the cost of business property in just one year. The following examines this effective combination.

1. Section 179 expensing: Under Section 179 of the Internal Revenue Code, a business may elect to currently deduct—or “expense”—business property placed in service during the year up to a specified maximum , which has been raised to $250,000 for tax years beginning in 2008, as well as a phase-out for qualified property acquisitions between $800,000 and $1.050,000. Prior to the Stimulus Act of 2008, the maximum annual deduction was $128,000, and the phase-out began at $510,000 for 2008. These figures will revert to their previous levels for 2009 and 2010.

Note that other special rules may apply. For instance, annual limits are imposed on vehicles used for business purposes. Also, the Section 179 deduction is limited to the amount of taxable income from the business.

2. Bonus depreciation deductions: The new economic stimulus act allows a business to deduct 50% of the cost of qualified business property placed in service in 2008. Unlike Section 179 expensing, this tax break generally is limited to new property.

For this purpose, qualified business property includes:

• Property with a cost recovery period of 20 years or less;
• Depreciable software that is depreciable over three years;
• Qualified leasehold improvements; and
• Water utility property.

Bonus depreciation may also extend through 2009 for qualifying property. This includes property with a cost recovery period of ten years or longer, certain transportation equipment and certain aircraft.

After Section 179 expensing is combined with bonus depreciation, the regular rules for depreciation are applied to the balance under the Modified Accelerated Cost Recovery System (MACRS). Deductions are claimed in this order: Section 179 deduction, bonus depreciation deduction and then MACRS deduction.

Example: For simplicity, assume that XYZ Construction Company buys five-year property costing $500,000 and places it in service in 2008. Under Section 179, XYZ is entitled to a maximum deduction of $250,000. It can then claim bonus depreciation of $125,000 (50% of $250,000 balance). Finally, using the 20% first-year deduction under MACRS, XYZ is entitled to an additional $25,000 deduction (20% of $125,000) in 2008.

This combination enables XYZ to deduct a total of $400,000 ($250,000 + $125,000 + $25,000) in 2008. The remaining $100,000 is available for MACRS deductions over the following four years.

Reminder: This is only a hypothetical example. Consult with a professional tax adviser concerning the maximum deductions available for a particular firm.

May 2008