Capital Gains

The Small Business Jobs Act of 2010, signed into law on Sept. 27, provides several incentives for businesses to make capital investments in 2010. These incentives include the extension of the additional “bonus” first-year depreciation deduction on the purchase of new depreciable property and the expanded ability of small and midsized businesses to fully deduct the cost of eligible new property.

Under tax legislation that was originally enacted following the attacks of Sept. 11 and extended by legislation at the onset of the economic recession, an additional first-year depreciation deduction has been allowed equal to 50 percent of the adjusted basis of qualified property placed in service. This provision was set to expire in 2009. The act extends the availability of this additional first-year depreciation deduction to qualified property acquired and placed in service during 2010 (or placed in service during 2011 for certain transportation property). The rules for the additional first-year depreciation deduction are found in Section 168(k)(2)(A)(iv) of the Internal Revenue Code, as amended by the act.

As under prior law, the amount of the additional first-year depreciation deduction is not affected by a short taxable year so that the full amount of the “bonus” depreciation may be taken in 2010 even though the property is acquired and placed in service at the end of the year. Also, as under prior law, a taxpayer may elect-out of additional first-year depreciation for any class of property. The amount of the “bonus” depreciation deduction serves to reduce the tax basis of the eligible property and this reduced basis is then amortized in accordance with the standard depreciation rules under the Modified Accelerated Cost Recovery System (MACRS).

Property qualifying for the additional first-year depreciation deduction must meet all of the following requirements. First, the property must either be depreciable tangible property to which the depreciation rules of MACRS apply with an applicable recovery period of 20 years or less; “off the shelf” computer software; or qualified leasehold improvement property. Second, the original use of the property must commence with the taxpayer. Third, the taxpayer must purchase the property and place the property in service in 2010. An extension of the placed in service date of one year (i.e., to Jan. 1, 2012) is provided for certain property with a recovery period of 10 years or longer and certain property used in the trade or business of transporting persons or property.

The act also extends through Dec. 31, 2010, the increased limitation on depreciation (or Code Section 179 deductions) that may be claimed on the purchase of automobiles, light trucks and vans. Under Code Section 280F, limitations are imposed on the amount of depreciation that may be claimed in any year with respect to motor vehicles. For passenger automobiles placed in service in 2010, the limit is $3,060 ($3,160 for light trucks and vans). For vehicles placed in-service in 2009, the limitation on first year depreciation was increased by an additional $8,000. The act extends this additional $8,000 first-year limitation for vehicles placed in service in 2010. Therefore, the aggregate limit on the deduction that may be claimed on automobiles and light truck or vans placed in service in 2010 is $11,060 and $11,160, respectively ($3,060/$3,160 base limitation plus $8,000 bonus limitation).

As an alternative to depreciating the cost of tangible property under MACRS over its useful life, a taxpayer may elect under Code Section 179 to deduct (or “expense”) the cost of the property in the year of purchase. Prior to the act, the maximum amount of new property purchased in 2010 that a taxpayer would be allowed to expense would be $250,000. The $250,000 amount would have been reduced by the amount by which the cost of eligible property placed in service by the taxpayer during the taxable year exceeds $800,000. The act increases the maximum amount a taxpayer may expense under Section 179 to $500,000 for property purchased in 2010 and 2011 and increases the phase-out threshold amount to $2 million. The amount claimed as a deduction under Section 179 may not exceed the taxpayer’s taxable income derived from all of the taxpayer’s trades and businesses.

Generally, only depreciable personal property is eligible to be expensed under Section 179. However, the act temporarily expands the definition of property qualifying for Section 179 to include certain real property consisting of qualified leasehold improvement property, qualified restaurant property and qualified retail improvement property. For this purpose, qualified leasehold improvement property means any improvement to an interior portion of a non-residential building if such improvement is placed in service more than three years after the date the building was first placed in service.

Qualified leasehold improvement property does not include any expenditures attributable to the enlargement of a building, escalators or elevators, any structural component benefiting a common area or the internal structural framework of a building. Qualified restaurant property means any improvement to a building if more than 50 percent of the building’s square footage is devoted to the preparation or on-premises consumption of prepared meals. Qualified retail improvement property is defined as any improvement to an interior portion of a building if such portion is open to the general public and is used in the retail trade or business of selling tangible personal property to the general public and such improvement is placed in service more than three years after the date the building was first placed in service.

The maximum amount with respect to real property that may be expensed under Section 179 in 2010 is $250,000. For example, assume that during 2010, a company’s only asset purchases are eligible equipment costing $100,000 and qualified leasehold improvements costing $350,000. Assuming the company has no other asset purchases during 2010, the maximum deduction under Section 179 that can be claimed for 2010 is $350,000 ($100,000 with respect to the equipment and $250,000 with respect to the qualified leasehold improvements).

The act also provides that deductions under Section 179 attributable to qualified real property that are disallowed under the trade or business income limitation may only be carried over to taxable years in which the definition of eligible Section 179 property includes qualified real property. Thus, under this provision, if the taxpayer’s Section 179 deduction for 2010 with respect to qualified real property is limited by the taxpayer’s trade or business income, such disallowed amount may be carried over to 2011. Any such amounts that are not used in 2011, plus any 2011 disallowed Section 179 deductions attributable to qualified real property, are treated as property placed in service in 2011 for purposes of computing depreciation. The carry-over amount from 2010 is considered placed in service on the first day of the 2011 taxable year.

The above carry-over provisions can be illustrated as follows: Assume that during 2010, a company’s only asset purchases are eligible equipment costing $100,000 and qualified leasehold improvements costing $200,000. Assuming the company has no other asset purchases during 2010, and has taxable income in 2010 of $150,000, the maximum Section 179 deduction that the company can claim for 2010 is $150,000, which is allocated pro rata between the equipment and the qualifying real property, such that the carry-over to 2011 is allocated $100,000 to the leasehold improvements and $50,000 to the equipment. Assuming that in 2011, the company had no asset purchases and had $0 of taxable income, the $100,000 carry-over from 2010 attributable to qualified leasehold improvements is treated as placed in service as of the first day of the company’s 2011 taxable year and the $50,000 carry-over allocated to equipment is carried over to 2012.

The intent of the Small Business Jobs Act of 2010 is to stimulate capital investment with the ultimate objective being the creation of manufacturing and construction jobs. The extension of the bonus depreciation rules and the expansion of the ability to expense certain asset purchases under Section 179 have been effective measures in prior tax stimulus legislation. The impact of these stimulus measures in the current environment is yet to be seen. •

Mark L. Silow is the administrative partner and chief operating officer of Fox Rothschild. Silow formerly was chairman of the firm’s tax and estates department. Silow’s work involves a broad range of commercial and tax matters including business and tax planning, corporate acquisitions and dispositions, real estate transactions, estate planning and employee benefits.