NewsFlash: Depreciation — Two Deductions for the Price of One

Aug 18, 2011

In certain circumstances, the Treasury Regulations allow the benefit of bonus depreciation twice. The Regulations expressly permit a taxpayer to take bonus depreciation under I.R.C. Section 168(k) on an asset, to subsequently trade or replace the asset in a like-kind exchange pursuant to I.R.C. Section 1031 or an involuntary conversion pursuant to I.R.C. Section 1033, and again take bonus depreciation on the carryover basis and excess basis, if any, in the replacement property. This scenario is especially beneficial in that the current bonus depreciation rules allow a full write-off (100% immediate cost recovery) of the cost of qualifying property. Property generally qualifies for bonus depreciation treatment if it has a recovery period of less than twenty years and the original use commences with the taxpayer (e.g. new property).

For example, assume a distribution company acquired a forklift on January 1, 2010 worth $200,000 for which they took 50% bonus depreciation of $100,000 and MACRS depreciation of $14,290. At the end of 2010, the adjusted tax basis in the forklift was $85,710. On January 1, 2011, the taxpayer entered into an exchange (qualifying for tax deferred treatment under I.R.C. Section 1031) by which the company received a new forklift in exchange for the forklift originally purchased in 2010 plus $25,000 in cash. Because the exchange occurred in 2011, the company may claim a 100% bonus first-year depreciation deduction in the amount of $110,710 ($85,710 + $25,000 paid). This represents the remaining basis at the time of the like-kind exchange plus the $25,000 in additional cash expended on the exchange for the new forklift. The net effect of the bonus depreciation and MACRS depreciation rules is that the company has fully deducted the $225,000 spent on the forklifts in just two tax years.

Please note that bonus depreciation is not allowable in cases where the exchanged or involuntarily converted property is both placed in service and disposed of in a like-kind exchange or an involuntary conversion in the same tax year.

This tax planning idea is particularly beneficial to certain manufacturing and distribution companies given the types of equipment utilized in the business operations. If you have additional questions regarding the benefits of bonus depreciation resulting from a like-kind exchange or involuntary conversion, please do not hesitate to contact your local Hein Tax Partner.