The passage of key legislation in May of this year introduced a couple of "limited-time" incentives that can offer significant tax savings on equipment purchases. The 2003 Jobs and Growth Tax Relief Reconciliation Act made significant improvements in both the Section 179 Expense Deduction and the Capital Depreciation Bonus for "qualifying" farm businesses.
Section 179 Expense Deduction The Section 179 Expense Deduction has been significantly increased from $25,000 to $100,000 on qualifying new or used equipment purchased and placed into service on or after Jan. 1, 2003. Also, the phase-out limit for this deduction has increased from $200,000 to $400,000. This means that this provision applies only to businesses that acquire no more than $400,000 of equipment over the course of a year. Note too, that for a business to use the full 179 Expense Deduction, it must have a taxable income of at least $100,000.
The Section 179 Expense Deduction lets you write off bigger amounts, faster. For example, 100 percent of a $100,000 piece of equipment can be written off in the first year of ownership. In addition, you can now spend up to $400,000 – twice the previous limit – on eligible equipment before the dollar-for-dollar deduction phase-out takes effect. In other words, every dollar in purchases over the $400,000 limit decreases the Section 179 deduction by $1. Under the new law, the $100,000 deduction will be in effect through 2005, after which time it reverts to $25,000.
Capital Depreciation Bonus The Capital Depreciation Bonus, which was introduced at 30 percent last year, has been increased to 50 percent on eligible new equipment purchased and placed into service on or after May 6, 2003. and before Jan. 1, 2005. "New equipment" are key words in that sentence. Used farm equipment qualifies for the Section 179 election but not the 50-percent or 30-percent bonus depreciation.
If you do purchase some used equipment, one strategy might be to take the Section 179 deduction against the used equipment, and the 50-percent bonus depreciation for new equipment purchased after May 5, 2003. If you purchased any new equipment before May 6, 2003, you could utilize the 30-percent bonus depreciation.
It is notable that the Capital Depreciation Bonus is an automatic deduction. Any business that does not desire to take advantage of this deduction must file an election with the tax return for each class of assets electing out of the depreciation bonus.
The Capital Depreciation Bonus allows you to deduct an additional 50 percent for the cost of new equipment in the first year of ownership. Standard depreciation guidelines apply to the remaining 50 percent.
Look at an example that applies to both the Section 179 Deduction and the 50 percent bonus first year depreciation (Table 1). Assume you purchase $400,000 of equipment after May 5, 2003. You can immediately claim $100,000 by way of the Section 179 deduction. $150,000 of the remaining $300,000 can be claimed under the 50 percent depreciation bonus. In this example, the regular MACRS 150 percent declining balance method and half-year convention is applied to the remaining $150,000.
|Equipment purchased after May 5, 2003||Depreciation Plus Section 179|
|Total Purchase Amount||$400,000|
|Section 179 Election||($100,000)|
|50% Depreciation Bonus||($150,000)|
|7-year MACRS Depreciation Method||($16,065)|
|Total First-Year Depreciation||($266,065)|
Trade-ins can also reduce your tax liability under the new Capital Depreciation Bonus. In a trade, the tax basis of the new equipment is equal to your out-of-pocket costs plus the remaining tax basis of the traded equipment. This is very significant in that you not only get to write off your out-of-pocket cost for the new equipment, but you also get to write off the remaining basis on your trade-in.
In the following example, a used cotton picker is traded with a tax basis of $20,000 remaining. The dealer gives you a trade-in allowance of $50,000 against a purchase of $200,000. $170,000 qualifies for the Capital Bonus Depreciation.
|Transactions||New Purchase With Trade-In|
|Purchase new cotton picker||$200,000|
|Trade-in used cotton picker||($50,000)|
|Tax basis remaining on used||$20,000|
|Tax basis on new picker||$170,000|
If you've been waiting to replace or upgrade equipment, this could be an excellent time to evaluate a purchase. Be sure to consult with your tax advisor about how the provisions of the Jobs and Growth Tax Relief Reconciliation Act of 2003 might benefit your operation.
Scott Stiles, Kelly Bryant, James Marshall and Rob Hogan are University of Arkansas Extension economists. Charlott Jones of Jones & Company LTD. and Julienne Penter of Goad & Widner, PLLC. (both of Jonesboro, Ark.) reviewed the article.