Bonus Depreciation Takes The Edge Off Mid-Quarter Convention Concerns
Since introduced as part of the Job Creation and Worker Assistance Act of 2002, bonus depreciation – the ability to claim increased first-year depreciation deductions for qualifying assets – continues to be a powerful tool for year-end business tax planning. This is particularly true for companies unable to write off machinery and equipment purchases by other means, such as:
- Code Section 179, which grants a tax deduction on qualifying equipment and/or software purchased or financed during the tax year.
- The de minimis safe harbor, which allows business owners to deduct all ordinary and necessary expenses incurred during the taxable year related to one’s trade or business.
Will Your Business Qualify For Bonus Depreciation?
In 2015, Congress passed the Protecting Americans From Tax Hikes Act of 2015 (PATH Act), which extended the first-year bonus depreciation deduction through 2019 at a rate of 50 percent through 2017, 40 percent for 2018 and 30 percent for 2019. Notably, the provision is permitted without proration based on the length of time an asset was in service during the tax year. That means, as long as the qualifying asset, or Modified Accelerated Cost Recovery System (MACRS) property, was bought and put into service even in the last few days of 2016, for example, the 50 percent first-year bonus write-off will be available to you when filing your company’s 2016 tax return.
An asset will qualify for bonus depreciation if it meets the following qualifications:
- MACRS rules can be applied to the asset with a recovery period of 20 years or less; the asset in question is computer software not covered by the amortization of goodwill and other intangibles rules of Section 197; or the asset is considered to be qualified improvement property, such as interior improvements to nonresidential buildings, or certain water utility property.
- The asset’s original use originates with the taxpayer, meaning the first time the asset was used was by the person claiming the depreciation, whether or not the use corresponds to the taxpayer’s use of the property.
Watch Out For The Mid-Quarter Convention?
Generally speaking, the half-year convention will apply when you compute depreciation deductions for the property that you’ve put into service at any point during the year. Under this convention, a business asset placed in service at any time during the tax year is generally treated as having been placed in service in the middle of that year. But there’s a catch. The half-year convention is only applicable if the property placed in service during the last three months of the tax year does not exceed 40 percent of all such property placed in service during the entire year. If it does exceed the 40 percent threshold, Section 168(d)(3) says the mid-quarter convention will be applied, which can severely limit the amount of depreciation you can take.
Use of the bonus first-year depreciation allowance has no impact on whether the mid-quarter convention applies because the 40 percent test is determined by the adjusted basis of the assets you placed in service during the year without reductions being made for bonus deprecation allowance. It’s also important to note that in a situation where the mid-quarter convention is triggered, the mid-quarter allowance will be factored on the adjusted basis of the property in question after the reduction is made for the bonus depreciation allowance.
Fortunately, thanks to the availability of bonus depreciation on most new machinery and equipment purchases, business owners can sleep a little more soundly knowing that the hazards of buying new assets – even in the last quarter of the year – is lessened since the 50 percent first-year bonus depreciation allowance is available even if the mid-quarter convention provision applies. That’s really good news for your budget!