Year-End Planning Tips: Capital Expenditures
For taxpayers who can afford to do so, now may be just the time to take advantage of significant tax benefits available with respect to certain types of capital expenditures effected before the end of 2011. The tax benefits come in two distinct flavors: (1) especially generous tax write-offs for business-use capital goods purchased this year, and (2) an opportunity to elect to deduct state and local sales taxes on purchases made in 2011, in lieu of state and local income taxes.
Under Section 168(k) of the Internal Revenue Code (the "Code"), taxpayers who purchase and place in service "qualified property" prior to January 1, 2012 are permitted a bonus first-year depreciation allowance of 100% of the cost of such property. For property placed in service at any time after December 31, 2011 and before January 1, 2013, the first-year bonus depreciation allowance is currently scheduled to drop to 50%. (The American Jobs Act of 2011, submitted by the Obama Administration to Congress on September 12, would extend the 100% first-year depreciation deduction to qualified property acquired and placed in service anytime through 2012.)
In addition to the accelerated tax write-off afforded by these bonus depreciation rules, the rules permit a 100% deduction for qualifying property without reduction or proration for property placed in service during the latter part of the year. Thus, qualifying property purchased and placed in service at any time during 2011 (including on December 31), will nevertheless give rise to a 100% write-off.
Property acquired and placed in service during 2011 is eligible for bonus depreciation if:
- It is either (1) property to which the modified accelerated cost recovery system (or MACRS) rules apply, with a recovery period of no more than 20 years, (2) computer software, (3) qualified leasehold improvement property or (4) water utility property;
- It is placed in service after September 8, 2010 and before January 1, 2013; and
- The original use of the property commences with the taxpayer.
"Qualified leasehold improvement property" for this purpose includes any improvement to the interior portion of a building that is nonresidential real property, if the improvement is made pursuant to a lease, is made by the lessee or sublessee of the improved interior space and is placed in service more than three years after the building is first placed in service. Certain types of improvements (such as elevators and structural enlargements of the building) are specifically disqualified for favorable treatment under the statute. In addition, under recent IRS guidance, certain types of "qualified restaurant property" and "qualified retail improvement property" may constitute qualified leasehold improvement property, and therefore be eligible for 100% bonus depreciation if placed in service during 2011.
Finally, special rules apply to (1) components of certain property (e.g., machinery) that is "self-constructed property," (2) reconditioned property, (3) property that is converted from personal to business use and (4) "heavy SUV" vehicles, for purposes of assessing eligibility for bonus depreciation under Code Section 168(k).
Section 179 Expensing
Under Section 179 of the Code, most taxpayers may elect to "expense" (that is, write off as a deduction in the year of purchase, rather than depreciating over several years) the cost of new or used tangible personal property employed in a trade or business, up to specified dollar limits. As a result of federal tax legislation enacted in 2010, the dollar limitations on immediately writing off such capital expenses incurred during 2011 are extraordinarily high. Thus, for qualifying purchases of property completed during 2011, up to $500,000 of qualifying expenses can be deducted, but this limitation will drop to $125,000 beginning in 2012. As with the bonus depreciation rules, the expensing allowance for 2011 is unaffected by the portion of the tax year for which the taxpayer has placed the qualifying property in service.
Because of the unusually high expensing allowance available under Section 179 for purchases during 2011, and because that allowance drops precipitously as of January 1, 2012, taxpayers contemplating purchases of needed business equipment should make every effort to complete any such purchases before the end of the year, in order to maximize the tax benefits attributable to accelerated write-offs of tangible business equipment. Moreover, while the bonus depreciation rules (discussed above) do not contain the dollar limitations that are applicable to Section 179 expense deductions, Section 179 permits expensing of used equipment, which may be more favorable to certain taxpayers.
State and Local Sales Tax Deduction
For tax years beginning before 2012, taxpayers who itemize deductions on their federal income tax returns may elect to take state and local general sales and use taxes as an itemized deduction, instead of deducting state and local income taxes. Taxpayers who make this election may either (1) deduct their actual sales and use taxes paid during 2011 or (2) use certain tables published by the IRS to determine the base sales and use taxes applicable to them, and then add to the amount derived from the tables the actual amount of sales tax paid with respect to certain "big-ticket" items, such as motor vehicles, boats, aircraft, homes (including mobile and pre-fabricated homes) and home building materials. The tables published by the IRS are compiled on the basis of the average consumption by taxpayers, on a state-by-state basis, of items other than such big-ticket items taking into account total available income, number of exemptions claimed and the rate of state general sales taxation.
This provision will generally be advantageous to taxpayers residing in states without an income tax, since that tax normally makes up the bulk of state tax liabilities generally available as a federal income tax deduction for itemized deduction filers. On the other hand, depending on the general sales tax rate in a given state, and assuming a resident of that state might be contemplating a big-ticket purchase that could produce an unusually large sales tax liability, it may behoove such a taxpayer to consider accelerating his purchase into 2011, and forgoing a deduction for state and local income taxes on his federal return, in favor of electing to deduct the sales taxes instead.