Bonus Depreciation Guidance Addresses Section 280F Limitation

On March 29, the IRS issued Rev. Proc. 2011-26, providing guidance on implementing and applying the new bonus depreciation provisions that were extended and enhanced by the Small Business Jobs Act of 2010 (the SBJA) and the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 (the Tax Relief Act). Included in this guidance is a favorable safe harbor regarding the increased amount of depreciation available for luxury automobiles weighing 6,000 pounds or less used in a business for which bonus depreciation is claimed. As discussed below, Rev. Proc. 2011-26 provides some relief from the strict section 280F limits on the amount of depreciation available for these automobiles in each year of the recovery period.

Background
Along with the retroactive extension of 50 percent bonus depreciation, the SBJA also increased by $8,000 the section 280F limitation on the amount of depreciation deductions allowed for certain passenger automobiles eligible for bonus depreciation.¹ Subsequent to the SJBA, the Tax Relief Act increased the additional first-year depreciation deduction from 50 percent to 100 percent of the adjusted basis of qualified property acquired and placed in service after Sept. 8, 2010 and before Jan. 1, 2012. The $8,000 increase in the section 280F limitation also applies to passenger automobiles eligible for the 100-percent bonus depreciation.² Rev. Proc. 2011-21 indicates that the first-year depreciation limitation for passenger vehicles placed in service in 2011 and eligible for bonus depreciation is $11,060 ($11,260 for light trucks or vans). However, under section 280F, if the basis of the automobile for which bonus depreciation is claimed exceeds the first year limitation, such excess is not recoverable until the first year succeeding the end of the recovery period (e.g., year six after a five-year recovery period). In Rev. Proc. 2011-21, the IRS alluded to this issue by noting that it intended “to issue additional guidance addressing the interaction between the 100-percent additional first-year depreciation deduction and section 280F(a) for the taxable years subsequent to the first taxable year.” Rev. Proc. 2011-26 provides such guidance in the form of a safe harbor depreciation method that mitigates this anomalous result.

Discussion
In general, if the unadjusted depreciable basis³ of a passenger automobile that qualifies for 100 percent bonus depreciation exceeds the section 280F limitation, the unrecovered basis is treated as a deductible expense in the first taxable year succeeding the end of the recovery period.⁴ For example:

If a calendar-year taxpayer places in service in Dec. 2010 a passenger automobile that costs $20,000, is not a truck or van, and is eligible for the 100 percent additional first year depreciation deduction, the 100 percent additional first year depreciation deduction for this property is limited to $11,060 under section 280F(a)(1)(A)(i)⁵ and the excess amount of $8,940 is recovered by the taxpayer beginning in taxable year 2016, subject to the limitation under section 280F(a)(1)(B)(ii).⁶

To mitigate this result, section 3.03(5)(c)(ii) of Rev. Proc. 2011-26 provides a safe harbor method that operates as follows:

1. In the placed-in-service year, the taxpayer will deduct the lesser of the 100 percent bonus depreciation or the first-year limitation amount under section 280F(a)(1)(A)(i);⁷
2. Next, the taxpayer will determine the unrecovered basis for its placed-in-service year as though it claimed 50 percent bonus depreciation;
3. The taxpayer will also determine the deductions for the subsequent years as though the taxpayer claimed the 50 percent, instead of 100 percent, bonus depreciation. Accordingly, the remaining adjusted basis will equal its unadjusted basis reduced by the amount of the 50 percent bonus depreciation deemed allowed or allowable, whichever is greater;
4. If there is no unrecovered basis, the taxpayer will determine the depreciation deduction for any subsequent year by multiplying the adjusted depreciable basis by the applicable depreciation rate for each taxable year.⁸ If any taxable year is less than 12 months, the depreciation deduction must be adjusted for a short taxable year.⁹ The taxpayer cannot use the optional depreciation tables for the subsequent taxable years.

Taxpayers adopt this safe harbor method by applying it on their federal tax return for the first taxable year succeeding the placed-in-service year of the passenger automobile.

Examples
Section 3.04 of Rev. Proc. 2011-26 provides the following two examples that help illustrate the new section 280F safe harbor method:

Example 5 – Application of section 280F(a) safe harbor method of accounting when there is unrecovered basis. In Dec. 2010, X, a calendar-year taxpayer, purchased and placed in service for use in its business a new passenger automobile that cost $20,000. The passenger automobile is not a truck or van, is five-year property under section 168(e), and is eligible for the 100 percent additional first year depreciation deduction. X does not claim any section 179 deduction for the passenger automobile. For 2010, X deducts $11,060 for the 100-percent additional first year depreciation for this property, which is the depreciation limitation for 2010 under section 280F(a)(1)(A)(i).¹⁰ X adopts the safe harbor method of accounting provided in section 3.03(5)(c)(ii) of Rev. Proc. 2011-26.

Under the safe harbor method of accounting, X is deemed to have claimed the 50 percent additional first year depreciation deduction for purposes of determining the unrecovered basis and the remaining adjusted depreciable basis of the passenger automobile. Accordingly, for 2010, the total depreciation allowable for the passenger automobile is deemed to be $12,000 [(50 percent multiplied by unadjusted depreciable basis of $20,000) + (20 percent multiplied by the remaining adjusted depreciable basis of $10,000)]. Thus, the unrecovered basis for the passenger automobile for 2010 is $940 ($12,000 deemed depreciation allowable less the $11,060 depreciation deduction for 2010) and that amount is recovered by X beginning in the 2016 taxable year, subject to the limitation under section 280F(a)(1)(B)(ii).

For 2011, the total depreciation allowable for the passenger automobile is deemed to be $3,200 (32 percent multiplied by the remaining adjusted depreciable basis of $10,000). Because this amount is less than the depreciation limitation of $4,900 for 2011,¹¹ X deducts $3,200 for the 2011 taxable year.

Example 6 – Application of section 280F(a) safe harbor method of accounting when there is no unrecovered basis. The facts are the same as in Example 5, except the cost of the automobile is $18,400. For 2010, X deducts $11,060 for the 100 percent additional first year depreciation for this property, which is depreciation limitation for 2010 under section 280F(a)(1)(A)(i).¹²

Under the safe harbor method of accounting, X is deemed to have claimed the 50 percent additional first year depreciation deduction for purposes of determining the unrecovered basis and the remaining adjusted depreciable basis of the passenger automobile. As a result, for 2010, the total depreciation allowable for the passenger automobile is deemed to be $11,040 [(50 percent multiplied by unadjusted depreciable basis of $18,400) + (20 percent multiplied by the remaining adjusted depreciable basis of $9,200)]. Thus, there is no unrecovered basis for the passenger automobile for 2010 because the 2010 deemed depreciation allowable of $11,040 is less than the 2010 depreciation deduction of $11,060.

Pursuant to section 3.03(5)(c)(ii)(D) of Rev. Proc. 2011-26, X must not use the optional depreciation tables for computing the depreciation deductions for the passenger automobile for the taxable years subsequent to the placed-in-service year. Therefore, assuming the applicable depreciation method and convention for the passenger automobile is the 200 percent declining balance method and the half-year convention, respectively, the total depreciation allowable for the passenger automobile for 2011 is $2,936 (40 percent multiplied by the adjusted depreciable basis of $7,340 [unadjusted depreciable basis of $18,400 less the total depreciation allowable for prior taxable years of $11,060]). Because this amount is less than the depreciation limitation of $4,900 for 2011,¹³ X deducts $2,936 as depreciation on its federal income tax return for the 2011 taxable year.

Actions to be Taken
The safe harbor method provided by Rev. Proc. 2011-26 should be carefully reviewed before being applied and adopted for eligible passenger automobiles in 2011 or 2012. This safe harbor should provide welcome relief to taxpayers by accelerating depreciation deductions for eligible passenger automobiles into tax years subsequent to 2010 or 2011, rather than having to wait to fully recover the bases in the automobiles until 2016 or 2017.

Natalie Tucker, Director, Washington National Tax

¹ For 2010, the maximum first year depreciation is $11,060 for passenger automobiles and $11,160 for light trucks or vans. The $8,000 increase is not indexed for inflation.
² See Section 3.03(1)(b) of Rev. Proc. 2011-26.
³ Defined in Treas. Reg. section 1.168(b)-1(a)(3)
⁴ See section 280F(a)(1)(B)(i).
⁵ See Table 7 of Rev. Proc. 2011-21.
⁶ Section 3.03(5)(c)(i) of Rev. Proc. 2011-26.
⁷ See Rev. Proc. 2011-21 for the limitation amount.
⁸ As determined under sections 6.03, 6.04, 6.05, and 6.06 of Rev. Proc. 87-57, 1987-2 C.B. 687, 692.
⁹ See Rev. Proc. 89-15, 1989-1 C.B. 816.
¹⁰ See Table 7 in Rev. Proc. 2011-21.
¹¹ Id.
¹² Id.
¹³ Id.