Archive for March 30th, 2011

Allow myself to reference…myself.

A few weeks ago, after the IRS provided the Section 280F  luxury auto depreciation limits for 2011 in Rev. Proc. 2011-21, the esteemed authors of this here blog hypothesized that the introduction of 100% bonus depreciation could create quite an anomalous result in years 2-6 for those taxpayers electing to maximize their first year auto depreciation

Long story short, we questioned whether in years 2-6, taxpayers would be limited to zero depreciation, since in each of these years they would be limited to the lesser of the Section 280F limits or the amount otherwise allowable under MACRS for that year. As we discussed in our original post:

Remember, in this hypothetical, we elected under Section 168 to apply the first year bonus depreciation rules. So under MACRS, all the allowable depreciation is taken in year 1, with nothing remaining for subsequent years. The fact that Section 280F limits the year 1 depreciation has no bearing on what the depreciation would be for years 2-6 under the normal rules. As a result, in those years, you would receive no depreciation deduction, before finally depreciating the entire remaining basis of the car in year 7 under Section 280F’s catch-up rule.

Today, the IRS issued Rev. Proc. 2011-26 and confirmed our belief. The procedure provides that if you decide to take the 100% first year bonus depreciation on a luxury auto, any cost unrecovered in year 1 is not deductible until year 7. For example, if you spent $20,000 on your new ride in December 2010 and chose to take the 100% bonus depreciation subject to the S280F limits, you would deduct $11,060 in year 1. The remaining $8,940 of unrecovered basis would not be deductible until 2016, the year after the end of the MACRS 5-year period.

Acknowledging this bizarre result, the IRS did offer up a safe harbor, which is about as easy to follow as Chinese arithmetic. It works as follows:

For the following steps, assume a $20,000 luxury auto placed in service during 2010, depreciable over 5 years MACRS.

1. In year 1, you deduct the lesser of your cost or the S280F first year depreciation limit ($11,060 in our example above),

2. In year 2, you must determine your remaining depreciable basis as if you took the 50% bonus depreciation, rather than the 100% bonus depreciation, in year 1.  This depreciation would be $12,000 in our example (50% * $20,000 cost =$10,000 plus first year MACRS depreciation of 20% of the remaining $10,000 basis.)

3. You then subtract the amount determined in Step 2 by the depreciation actually taken in Step 1 ($12,000-$11,060=$940.) This result, if positive, is not deductible until the year after the MACRS period expires, or 2016 in our example.

5. The remaining undepreciated basis of $8,000 is depreciated as if the taxpayer took the 50% depreciation in year 1 instead of 100% depreciation. So in years 2-6, the depreciation is equal to the lesser of the MACRS depreciation (32%*$10,000=$3,200 for year 2) or the S280F limit in place ($4,900 for year 2). In the event any basis reamins undepreciated after the end of the MACRS recovery period because of the S280F limitations, it would be recovered in year 7, along with the amount from Step 3.

Simple, right?

There are additional rules for what happens if Step 3 results in a negative number, but I don’t want anyone’s head to explode, like that guy  from The Running Man. The point is, unless you want to go five years without any depreciation deductions on your luxury auto, you may want to consider this safe harbor. It is adopted by simply applying this methodology in year 2 of the depreciable life of your luxury auto.

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