Q: I understand that that the rules for bonus depreciation and Section 179 expensing were changed by Congress in late December 2010. Can you explain what these changes were and how they apply to income-producing real estate assets? What are the practical implications for small-business owners with or without rental properties?
A: In late December Congress passed the Tax Relief Act of 2010. Among the many provisions in this law were two that extended and increased bonus depreciation and Section 179 expensing — laws that allow all or most of the cost of many types of business property to be deducted in a single year rather than depreciated over several years.
There are two different deductions involved.
First, there is the Section 179 deduction, also called "first-year expensing." This allows business owners to deduct the entire cost of new or used business property in a single year, up to an annual limit. However, there are significant limitations on when Section 179 can be used.
Section 179 can be used only to deduct tangible personal property used by a business (plus off-the-shelf software). You can’t use Section 179 to deduct the cost of:
- permanent structures attached to land, including buildings and their structural components, fences, swimming pools, or paved parking areas;
- property used outside the U.S.; or
- air-conditioning and heating units.
Non-permanent property attached to a building is deductible. For example, refrigerators, grocery store counters, printing presses, testing equipment, and signs are all deductible under Section 179.
Unfortunately, personal property used in residential rental property is specifically excluded. Thus, you can’t use Section 179 to deduct the cost of personal property items you place in your residential rental property. For example: kitchen appliances, carpets, drapes or blinds.
The only exception is for property in hotels, motels or vacation homes where the guests stay less than 30 days.
So what can a residential landlord use Section 179 for? Only for personal property not contained in your rental property, such as computers, office equipment, and office furniture you use in your office or other place of business. It can also be used for cars and other vehicles.
Section 179 expensing may only be used for used or new property you purchase for cash (cash includes amounts you borrow). It may not be used for leased property or property you inherit or are given. Nor may it be used for property you buy from a relative, or from a corporation or other organization you control.
If you use property both for business and personal purposes, you may deduct it under Section 179 only if you use it for business purposes more than half the time. The amount of your deduction is reduced by the percentage of personal use.
You’ll need to keep records showing your business use of such property. If you use an item for business less than half the time, you must depreciate it.
There is a limit on the total amount of business property expenses you can deduct each year using Section 179. The 2010 Tax Relief Act greatly increased these limits. First, the limit for 2010 was retroactively increased from $250,000 to $500,000. The 2011 limit will be the same as 2010.
The limit was scheduled to go down to $25,000 in 2012, but Congress increased it to $125,000 for that year. For tax years beginning after 2012, the maximum expensing amount will drop to $25,000.
The other deduction is first-year bonus depreciation. First adopted as a temporary measure in 2002, bonus depreciation allows business owners to deduct a substantial percentage of the cost of qualified property in a single year, and then depreciate the remaining cost under the normal rules.
Typically, bonus depreciation has been pegged at 50 percent. For example, if you placed in service a $1,000 refrigerator for a rental unit, you’d be able to deduct $500 of the cost the first year using bonus depreciation.
For the first time ever, Congress increased bonus depreciation to 100 percent for qualified property placed in service after Sept. 8, 2010, and before Jan. 1, 2012. For example, if you placed in service a $1,000 refrigerator for a rental unit in December 2010, you can deduct the entire cost in 2010.
There is no limit on the amount of property you can deduct in one year using bonus depreciation. If you placed in service property between Jan. 1, 2010, and Sept. 8, 2010, you may deduct 50 percent of the cost the first year using bonus depreciation. In 2012, bonus depreciation will go down to 50 percent. Bonus depreciation is scheduled to end in 2013.
As with Section 179 expensing, there are significant limits on when you can use bonus depreciation. You may take it only for property that:
- is new, and
- has a useful life of 20 years or less (this includes most types of property other than real property).
Bonus depreciation can’t be used for real property — thus it may not be used for buildings and building components. But it can be used for new personal property in a rental building that is not a building component, such as refrigerators, stoves, carpeting, and drapes.
It may also be used for office furniture, computers and other equipment used for a landlord business. It is also available for depreciable land improvements such as swimming pools and driveways.
Bonus depreciation is taken after, and in addition to, Section 179 expensing. With the Section 179 limit at $500,000 through 2011, you many not have any property left to depreciate after you use the Section 179 deduction.
However, Section 179 expensing may be used only for property that is used more than 50 percent of the time for business.
As a general rule, this 50 percent business-use threshhold does not apply to bonus depreciation. However, there is an exception for listed property: items that can be easily used for both personal and business purposes, such as cars or computers. Listed property must be used over 50 percent of the time to qualify for bonus depreciation.
Also, with Section 179 you may only deduct in a single year an amount equal to your annual business income. There is no such limit on bonus depreciation. Therefore, you can take bonus depreciation even if your business shows a loss.
Stephen Fishman is a tax expert, attorney and author who has published 18 books, including "Working for Yourself: Law & Taxes for Contractors, Freelancers and Consultants," "Deduct It," "Working as an Independent Contractor," and "Working with Independent Contractors." He welcomes your questions for this weekly column.