The Internal Revenue Service (IRS) issued temporary regulations that provide detailed guidance on the use of the additional first-year 30 percent depreciation deduction ("depreciation bonus") created by Congress in 2002 and expanded to 50 percent as part of the Jobs and Growth Act earlier this year.
The regulations published by the IRS in the recent Federal Register are intended to serve both as temporary regulations on the use of the depreciation bonus and as proposed permanent regulations. The temporary regulations were effective Sept. 8, 2003. Comments on the proposed regulations are due by Dec. 8, 2003. Additionally, a public hearing on the depreciation rules has been scheduled for Dec. 18, 2003.
Under the new IRS rules and recent laws passed by Congress, property is eligible for either the 30 percent or the 50 percent depreciation bonus if it meets four criteria:
1) The property is of a specified type;
2) The original use of the depreciable property commences with the taxpayer after a certain date;
3) The property is acquired by the taxpayer within a specific time window; and
4) The property is placed in service by a specified date.
"Specified Type"
Property is eligible for the depreciation bonus if it is depreciable under the Modified Accelerated Cost Recovery System (MACRS) and has a recovery period of 20 years or less. Certain computer software, water utility property, and qualified leasehold improvement property also qualifies for the additional first-year depreciation deduction.
"Original Use"
The depreciation bonus applies only to new property. To qualify for the 30 percent depreciation bonus, the original use of the eligible property must commence with the taxpayer claiming the depreciation bonus after Sept. 10, 2001. To qualify for the expanded 50 percent depreciation bonus, the original use of the property must commence after May 5, 2003.
The regulations answer a question frequently asked in the equipment industry: How does the depreciation bonus apply to rent-to-own equipment transactions? The regulations clarify that if property is placed in service by a lessor after the required date and sold to a purchaser within three months of the date on which the property was originally placed in service, the purchaser is eligible to claim the depreciation bonus as long as the user of the equipment has not changed during the three-month period.
In other words, assuming the other requirements are met, an equipment purchaser in a rent-to-own transaction is eligible to claim the depreciation bonus if they purchase the machine within three months of the date on which it is first put into service and if the machine has had only one user during that three-month period. If the equipment is rented or leased for more than three months or if there have been multiple users, under the new IRS regulations the purchaser cannot claim the depreciation bonus.
"Acquisition of Property"
To qualify for the depreciation bonus, the property must also be acquired during a specific time window. Property acquired after Sept. 10, 2001 and before Jan. 1, 2005 is eligible for the 30 percent depreciation bonus enacted in 2002 as long as a written binding contract to purchase the property did not exist prior to Sept. 11, 2001.
Property acquired after May 5, 2003 and before Jan. 1, 2005 qualifies for the 50 percent depreciation bonus enacted this past May as long as no written binding contract for the acquisition of the property was in effect before May 6, 2003.
The regulations define in specific terms what the IRS will consider a binding contract. Among other things, the regulations state that an option to acquire or sell property is not considered a binding contract, nor is a supply agreement that does not specify the quantity and design specifications of the property to be purchased.
"Placed in Service"
Finally, to qualify for the depreciation bonus, the property in question generally must be put in service before Jan. 1, 2005. The "placed in service" provision of the new regulations also clarifies that in a qualified rent-to-own transaction that takes place within three months of the equipment’s first use (see discussion under "Original Use" above) property purchased by an equipment lessee will be treated as placed in service by the purchaser during the three month period "but not earlier than the date of the last sale."
For more information, links to the new depreciation bonus rules and additional cost recovery information can be found at: http://www.depreciationbonus.org.
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