As part of the Economic Stimulus Act of 2008, depreciation rules were amended to allow a 50-percent bonus deduction for depreciating a qualifying property. In general, any property depreciable under the modified accelerated cost recovery system (MACRS), with a recovery period of 20 years or less, qualifies for an immediate 50-percent write-off if placed in service after December 31, 2007 and before January 1, 2009.
Obviously, the 50% first year write-off is a great benefit for businesses that require high capital investment, but companies with current year net operating losses or loss carry-forwards from prior years will find it difficult to justify purchasing equipment in order to take the bonus depreciation. This created a quandary for Congress since the whole point of allowing the bonus depreciation was to encourage companies to purchase equipment as a means of stimulating the economy.
With the passage of the Housing Assistance Tax Act of 2008 (HATA), Congress found a way to address this issue by providing for a limited refund of Alternative Minimum Tax Credit and Research Tax Credit Carry-Forwards. Instead of utilizing the first year bonus depreciation, companies can elect to forego the deduction. Those companies with AMT or Research Credits generated in tax years beginning before January 1, 2006 can claim a refundable credit equal to 20% of the foregone depreciation expense.
Here’s how it works.
Suppose you generated eligible credit carry-forwards equal to $100,000 and you expect to have a current year loss of $100,000 (before depreciation of new equipment). Now, let’s suppose your company is in need of a new machine that will require a $100,000 investment. Typically, that machine is depreciated over five years for tax purposes.
Obviously, the first year bonus depreciation of $50,000 will have no immediate cash effect on your 2008 tax picture, but HATA provisions will allow you to benefit from your unutilized AMT credits. Assuming you placed the equipment in service in
September 2008, first year depreciation, including bonus depreciation, would be $60,000 ($50,000 bonus depreciation and 20% times the remaining depreciable basis of $50,000). Without bonus depreciation, the first year depreciation would be $20,000. The law will allow a credit equal to the allowed “bonus depreciation”, which is 20% of the difference between the expense allowed with and without the first year 50% deduction, subject to certain limitations. In this case, that amount would be $8,000.
To complicate things a bit more, if you make the election to obtain a refund of some of your AMT or Research credits, you will also be required to depreciate the new equipment using the straight-line method over its recovery life, instead of accelerated depreciation. This means the use of the election to obtain immediate cash from the AMT or Research credit carry-forwards cannot be taken lightly.
To qualify for this special election, property must be placed in service after March 31, 2008 and before January 1, 2009. Moreover, property that was subject to a binding purchase contract prior to March 31, 2008 is not eligible, but certain property that is contracted for after March 31, 2008 and before January 1, 2009 (and placed in service after January 1, 2009) may also be eligible.
If you have AMT or Research credit carry-forwards from tax years that began before January 1, 2006, you may want to consider applying the new rules on your 2008 income tax return. As with all things related to taxes, though, the computations can be tricky. Give us a call and let’s discuss how the new rules will affect you.