By Blumkin, Peter, 06/16/2014
Note. This is an important update to the article (below) which was originally published to our website in May 2013. Due to some expired provisions and uncertain future tax developments, a need arose to keep readers current on this subject, in particular with regard to expiration of the Bush-era tax breaks and new proposed legislation that may affect depreciation benefits.
Over the past decade, business owners have been reaping generous tax benefits by writing off their new equipment purchases, including certain qualified leasehold improvements. The special first-year allowable write-off, called “bonus depreciation”, initially was set at 30% of the asset’s purchase price and, over the years, was raised to 50%. For the period of September 9, 2010 through December 31, 2011, it even reached 100%. What many taxpayers fail to realize; however, is that some or all of the previously-derived tax benefits could be negated when the affected assets are disposed of.
It’s important, therefore, to review the rules which should be considered carefully before disposing of a business asset.
Any amount of gain realized on the sale of business assets is first allocated to prior depreciation taken and is taxed as ordinary income instead of capital gain. Depreciation recapture applies to the disposition of an asset that is held more than a year and which is subject to depreciation or amortization and disposed of at a gain. A common misconception exists that a business asset disposed of at a gain automatically qualifies for a 15% preferential capital gain tax rate (20% for the taxpayers in a 39.6% tax bracket). This is where the recapture rules come into play.
The IRS reclassifies the character of the gain on the disposed asset from that of capital into ordinary to the extent the depreciation or amortization deduction is allowed or allowable. All tangible depreciable personal property and intangible amortizable personal property are subject to the recapture provisions. The impact of recapture is somewhat lessened on the gain derived from real property disposition. Depreciation taken on that property is subject to the 25% tax rate, to the extent of the gain. There is still some good news: Any gain in excess of the amounts recaptured is treated as capital gain and currently taxed at 15% or 20%. Recapture provisions can also apply when selling a business.
A special situation applies to an asset disposed of
on an installment basis. Whereas the gain on the installment sale is recognized in income as the payments come in, any depreciation recapture becomes taxable in the year of sale, even if no cash is received. The far-reaching repercussions of these rules can be felt when selling or transferring a partnership interest. A proportionate share of an individual partner’s indirect ownership of the partnership’s depreciable fixed assets is also subject to ordinary income recapture rules.
With proper planning, depreciation recapture can be reduced, shifted, postponed or even eliminated.
Reducing recapture effects can be accomplished by recognizing ordinary income when the taxpayer is in a low tax bracket or when he or she has a net operating loss carryover. If a taxpayer makes a bona fide gift of depreciable property, the recapture potential will be shifted to the donee. One can postpone the recapture provisions by completing a like-kind exchange in which case, the recapture is not triggered upon the exchange but rather, is carried over to the replacement property.
While the Bush-era tax breaks officially expired at the end of 2013, there is still time to utilize “bonus depreciation” or elect to take a Sec. 179 deduction on 2013 tax returns, filed by their extended due date. As of the date of this article, the 2014 tax year affords no “bonus depreciation” and a very limited Sec. 179 deduction: $25,000. As part of his 2015 budget, President Obama has proposed to make $500,000 a permanent Sec. 179 deduction; however, the proposed budget does not provide for the extension of the “bonus depreciation” provision. Pending future legislation, business owners should consider the expiration of these provisions when purchasing large equipment items, as the immediate write-offs they were so accustomed to seeing in recent years might not be at their disposal. It would also be prudent to follow further developments in this area when planning any future fixed asset acquisitions.
About Peter Blumkin
Peter Blumkin, CPA, CGMA is a Senior Manager in the Tax Department at Marks Paneth LLP. Mr. Blumkin, who joined Marks Paneth in 2009, has more than 15 years of experience advising high-net-worth individuals and their businesses. He also has strong tax knowledge in corporate and partnership areas. He is a member of New York State Society of CPAs and American Institute of CPAs.
Contact Peter Blumkin:
Phone: (212) 201-2208; Fax: (212) 201-2209