IRS Issues Guidance on Electing Out of 50% Additional First-Year Depreciation

BY JACK DONOVAN AND JANE ROHRS

Editor's note: This article appears in the January 2009 issue of The Tax Adviser, the AICPA's monthly journal of tax planning, trends and techniques.

The IRS has issued Rev. Proc. 2008-65, which provides guidance on new Sec. 168(k)(4), added by Section 3081 of the Housing and Economic Recovery Act of 2008, P.L. 110-289. Sec. 168(k)(4) allows corporations to elect out of claiming the 50% additional first-year depreciation for new property acquired after March 31, 2008, and placed in service before January 1, 2009. Under Sec. 168(k)(4), corporations may elect to increase their business credit limitation under Sec. 38(c) (but only for certain research credits determined under Sec. 41(a)) or their alternative minimum tax (AMT) credit limitation under Sec. 53(c). Rev. Proc. 2008-65 is effective October 10, 2008.

 

ELIGIBLE QUALIFIED PROPERTY

Eligible qualified property for purposes of Sec. 168(k)(4) is property that is eligible for bonus depreciation under Sec. 168(k)(2), with certain modifications to reflect the revised dates in Sec. 168(k)(4). Thus, eligible qualified property is tangible property (and certain computer software):

 

  • With a MACRS recovery period of 20 years or less;
  • The original use of which begins after March 31, 2008;
  • That is acquired after March 31, 2008, and before January 1, 2009, provided no written binding contract was in effect before March 31, 2008 (special rules apply to passenger aircraft and to property with a long production period); and
  • That is manufactured, constructed, or produced for the taxpayer’s own use and is manufactured, constructed, or produced after March 31, 2008, and before January 1, 2009.

 

If new property is placed in service after March 31, 2008, and is the subject of a sale-leaseback transaction within three months of the placed-in-service date, the taxpayer-lessor is treated as the original owner and the original placed-in-service date by the taxpayer-lessor is not earlier than the date on which the property is used by the lessee under the leaseback.

 

SEC. 168(k)(4) ELECTION

Rev. Proc. 2008-65 provides ordering rules for making the elections out of bonus depreciation under Sec. 168(k)—the election under Sec. 168(k)(2)(D)(iii) and the Sec. 168(k)(4) election. Under the procedure, a corporate taxpayer applies the election out of bonus depreciation under Sec. 168(k)(2)(D)(iii) first. The taxpayer makes that election on an asset-class basis. If an election is made under Sec. 168(k)(2)(D)(iii) for a certain class of property, that class of property is not qualified property under Sec. 168(k)(2) or eligible qualified property under Sec. 168(k)(4).

 

The corporate taxpayer makes the Sec. 168(k)(4) election for its first tax year ending after March 31, 2008. Once the election is made, it applies to all eligible qualified property placed in service by the taxpayer in the taxpayer’s first tax year ending after March 31, 2008, and any subsequent tax year and may be revoked only with the Service’s consent. If the taxpayer wants to apply the election to subsequent tax years, it must make the election for its first tax year ending after March 31, 2008, even if the taxpayer does not place in service eligible qualified property in its first tax year. If a Sec. 168(k)(4) election is made, the straight-line depreciation method should be used for all eligible qualified property.

 

Importantly, under the revenue procedure all corporations that are treated as a single employer under Sec. 52(a) are treated as one taxpayer for purposes of Sec. 168(k)(4) and the election thereunder. Thus, for example, if the common parent of a consolidated group makes the election under Sec. 168(k)(4) for one member of the affiliated group, then all members of the affiliated group are treated as one taxpayer for purposes of Sec. 168(k)(4) and as having made the election.

 

The IRS intends to issue separate guidance on the time and manner of making the Sec. 168(k)(4) election.

 

BONUS DEPRECIATION

The bonus depreciation amount is defined in Sec. 168(k)(4)(C)(i) as an amount for any tax year equal to 20% of the excess (if any) of:

 

1.       The aggregate amount of depreciation allowable under Sec. 168(k)(1) for all eligible qualified property placed in service by the taxpayer during the tax year, over

2.       The aggregate amount of depreciation that would be allowable under Sec. 168 without regard to subsection (k)(1) for all eligible qualified property placed in service by the taxpayer during the tax year.

 

In computing the bonus depreciation amount, Rev. Proc. 2008-65 provides that the applicable convention rules under Sec. 168(d) apply in computing the aggregate amount of depreciation; however, this computation is made without regard to any elections to use the 150% declining balance method, the straight-line method, or the alternative depreciation system (ADS), or the requirement to depreciate eligible qualified property using the straight-line method. In addition, for a corporation that is a partner in a partnership, the corporation’s computation of aggregate depreciation does not include depreciation property placed in service by the partnership. Special rules apply for passenger aircraft and long production period property.

 

Rev. Proc. 2008-65 provides that the bonus depreciation amount must not exceed the maximum increase amount reduced by the sum of the bonus depreciation amounts determined under Sec. 168(k)(4)(C) for all preceding tax years. The maximum increase amount is the lesser of: (1) $30 million or (2) 6% of the sum of the business credit increase amount and the AMT credit increase amount. The business credit increase amount is the portion of the credit allowable under Sec. 38 for the first tax year ending after March 31, 2008, that is allocable to business credit carryforwards to such tax year that are from tax years beginning before January 1, 2006, and properly allocable to the research credit determined under Sec. 41(a). A business credit carryforward allocable to the research credit that was from a tax year beginning before January 1, 2006, but has expired before the first tax year ending after March 31, 2008, is not taken into account in calculating the business credit increase amount.

 

Rev. Proc. 2008-65 defines the AMT credit increase amount as the portion of the minimum tax credit under Sec. 53(b) for the first tax year ending after March 31, 2008, determined by taking into account only the adjusted minimum tax for tax years beginning before January 1, 2006. Minimum tax credits are treated as allowed on a first-in, first-out basis.

 

ALLOCATION OF BONUS DEPRECIATION AMOUNTS
Rev. Proc. 2008-65 allows a taxpayer to specify the portion of the bonus depreciation amount for the tax year that is to be allocated to the business credit limitation under Sec. 38(c) and the AMT credit limitation under Sec. 53(c). However, the bonus depreciation amount allocated to the business credit limitation under Sec. 38(c) must not exceed the excess of the business credit increase amount over the bonus depreciation amount allocated by the taxpayer to the limitation for all preceding tax years. The bonus depreciation amount allocated to the AMT credit limitation under Sec. 53(c) must not exceed the excess of the AMT tax credit increase amount over the bonus depreciation amount allocated by the taxpayer to the limitation for all preceding tax years.

 

Rev. Proc. 2008-65 sets forth an example of a corporation with $10 million in business credit carryforward and $590 million in AMT credit carryforward. The sum of these carryforwards ($600 million) multiplied by 6% equals $36 million. Thus, the maximum increase amount is $30 million. Of this $30 million, up to $10 million (the full amount of the business credit carryforward) may be allocated to the business credit limitation.

 

IMPLICATIONS

Taxpayers will need to carefully evaluate the bonus depreciation election ordering rules to maximize the depreciation deduction and the refundable credit. By permitting taxpayers to first make the election out of bonus deprecation under Sec. 168(k)(2)(D)(iii), taxpayers may still depreciate such elected classes of property using MACRS. For all other property for which a taxpayer (which for purposes of Sec. 168(k)(4) includes all affiliated group members filing a consolidated return) elects not to claim bonus depreciation, all eligible qualified property placed in service by the taxpayer (which includes all members of a consolidated group) must be depreciated using the straight-line method, regardless of whether such property results in additional refundable credits.

 

Rev. Proc. 2008-65 states that the IRS intends to publish separate guidance on the time and manner for making the Sec. 168(k)(4) election and for allocating the credit limitation increases allowed by the election.

 

An October 6, 2008, posting on the IRS website directs taxpayers with fiscal years ending after March 31, 2008, to not make the Sec. 168(k)(4) election and claim the refundable credit on their original 2007 return. Instead, the Service directs these taxpayers to make the election and claim the credit on a subsequently filed amended return. Taxpayers intending to make the election and claim the refundable credit on an amended 2007 return may claim the bonus depreciation deduction on their original 2007 return for all classes of property for which they did not make the Sec. 168(k)(2)(D)(iii) election out of bonus depreciation.

 

It is important to note that, as stated above, Rev. Proc. 2008-65 requires taxpayers to make the election on their first tax year ending after March 31, 2008, even if they do not place any eligible qualified property in service in its first year. However, because fiscal-year taxpayers must make the Sec. 168(k)(4) election on amended 2007 tax returns, this will afford fiscal-year taxpayers additional time to make the decision based on their fiscal 2008 activities.

 

By Jack Donovan, J.D., LL.M., and Jane Rohrs, CPA, Ernst & Young, LLP, Washington, DC

 

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