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New Depreciation Rules Can Save Big Bucks At Tax Time
By John Day

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The 2003 Tax Act increases the special depreciation allowance from 30% to 50%
If you decide to use the special depreciation allowance (30% or 50%) on your 3-year rental inventory property then you must use it for "all" the 3-year property.

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Last year, I wrote two articles on how the depreciation rules affect Rent to Own inventory property and non-rental inventory property under the titles, "Understanding Rental Merchandise Depreciation" and "Maximizing Rental Inventory Depreciation". It might be good to review them because there are some new rules for 2003 in which you might be interested.

The 2003 Tax Act increases the special depreciation allowance from 30% to 50% for certain qualifying property. To qualify for the 50% special depreciation allowance, property must be acquired after May 5, 2003 and placed in service before January 1, 2005.

The 30% special depreciation allowance continues to be available for qualifying property acquired and placed in service prior to May 6, 2003. In addition, the 2003 Tax Act extends the acquisition dates for property qualifying for the 30% special depreciation allowance from September 11, 2004, to January 1, 2005.

To be treated as "qualified property," an asset must fall within one of the four asset classes listed below and meet the original use, timely acquisition, and timely placed-in-service requirements:

  • Class #1 – Modified Accelerated Cost Recovery System (MACRS) recovery property with a recovery period of 20 years of less.
  • Class #2 – Computer software
  • Class #3 – Water utility property
  • Class #4 - Leasehold improvements – only nonresidential property under certain conditions.

You can elect to use the 30% special depreciation allowance instead of the 50% special depreciation allowance for all property in a class placed in service during the year or you can elect not to claim the special depreciation allowance for all property in a class placed in service during the year. This means they don’t allow you to claim the 30% rate on one item and the 50% rate on another item in the same class. Nor can you claim both the 50% rate and the 30% rate for the same property.

Here is a cautionary note because it gets even trickier. The four classes mentioned above define "qualified property". The "classes" of property referred to in the context of "how" to use the special depreciation allowance in the above paragraph relate to "class-lives" such as 3-year; 5-year; 7-year, etc. For instance, if you decide to use the special depreciation allowance (30% or 50%) on your 3-year rental inventory property then you must use it for "all" the 3-year property. You are not allowed to elect and not elect within a class. You can, at the same time, decide to elect not to use the bonus depreciation for your 7-year property, but that means "all" 7-year property.

Depreciable Basis
To figure depreciable basis for purposes of the 30% or 50% special depreciation allowance, multiply the property’s cost or other basis by the percentage of business use and reduce that amount by any 179 expense deduction.

Keep in mind that rental property does not qualify for the 179 election to expense deduction. So, if you decided to use the 50% rate on your new, qualified rental property which has a class life of 3 years, the following would be an example of how it works:

Qualified rental inventory $50,000
Bonus depreciation (50% x $50,000) $25,000 deduction
Remaining basis $25,000

Apply the regular 3-yr 200% Double-Declining Balance Method or 33.33 depreciation rate to the remaining basis of $25,000.

33.33% x $25,000 = $8,333

The total depreciation deduction for rental inventory property is:

Bonus depreciation (50%) $25,000
Regular depreciation $8,333
Total depreciation deduction $33,333

This extra deduction could save some big tax bucks at the end of the year.

New Code Section 179 rules
The news here is that the new law contains several changes relating to the Section 179 deduction for tax years beginning after 2002 and before 2006. The most relevant changes are that the maximum deduction is increased from $25,000 to $100,000, and the investment limit is increased from $200,000 to $400,000.

Publication 946 "How to Depreciate Property"
I’ve hit the highlights, but it would be wise to read Pub 946 or check with your tax advisor to make sure you follow all the rules. In the Table of Contents, find Section 3, "Claiming the Special Depreciation Allowance". It will provide all the details.

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