The Tax Cuts and Jobs Act has changed the tax rules for many taxpayers and many transactions, including the tax rules that govern depreciation or lease deductions for business autos, trade-ins of autos, write-offs for heavy sport utility vehicles (SUVs), and deductions for employee-provided autos. This 2-part Special Study takes a detailed look at the revised rules. This article, Part I, covers how the new law affects the interplay between the depreciation deduction rules and the luxury auto limits. Part II of this article will cover the new rules for heavy SUVs used for business, leased luxury autos, business auto trade-ins, and employee-provided autos.
General Rules for Depreciating Business Autos
Purchased business autos generally are treated the same way as other types of depreciable 5-year MACRS property, namely they are depreciated over five years using 200% declining balance depreciation, with a built-in switch to straight line. Because MACRS depreciation generally treats property as placed in service in the midpoint of the placed-in-service year, yielding only half of the otherwise allowable depreciation for the placed-in-service year, the actual depreciation period is six years.
Applying IRS’s optional table for 5-year MACRS property, the regular depreciation percentages are 20% for the first year, 32% for the second, 19.2% for the third year, 11.52% for each of the fourth and fifth years, and 5.76% for the sixth year. In each case, the percentage is applied to the auto’s unadjusted depreciable basis (generally, basis for gain or loss).
Regular Luxury Auto Dollar Caps
The deduction normally obtained by applying the Code Sec. 168 rules (and the Code Sec. 179 expensing rules) to autos is limited by the so-called “luxury auto dollar caps” of Code Sec. 280F. These dollar caps, which were designed to limit depreciation deductions for expensive autos, are periodically adjusted for inflation and vary with the placed-in-service year and the depreciation year. Thus, the maximum annual depreciation/expensing deduction for a business auto is the lesser of
- The otherwise allowable depreciation/expensing allowance, or
- The applicable luxury auto dollar cap.
For autos that were first placed in service during 2017, and either were not eligible for bonus depreciation (e.g., car was used) or the purchaser elected out of bonus depreciation, annual depreciation/expensing deductions are as follows. In each case, the percentage is applied to the auto’s unadjusted depreciable basis.
- First (placed-in-service) year, lesser of 20% or $3,160.
- Second year, 32% or $5,100.
- Third year, 19.2% or $3,050.
- Fourth year, 11.52% or $1,875.
- Fifth year, 11.52% or $1,875.
- Sixth year, 5.76% or $1,875.
For light trucks and vans, IRS uses a different CPI (Consumer Price Index; i.e., measure of price changes paid by urban customers for various goods and services) component for figuring the inflation adjustment, which generally results in higher annual dollar limits. For example, the first-year depreciation dollar cap was $3,560 for light trucks and vans placed in service in 2017.
The luxury auto dollar caps represent the maximum annual depreciation allowed if there is no personal use of the auto. These amounts must be reduced where the auto is not used 100% for business/investment purposes.
Because of the dollar caps, a business auto, even if used 100% for business, is ordinarily not fully depreciated when its normal MACRS recovery period ends. If a taxpayer continues using an auto for business after the end of the normal recovery period, he or she depreciates any unrecovered basis in those subsequent years, subject to a dollar cap (e.g., $1,875, for autos placed in service in 2017), until the auto is fully depreciated or disposed of.
Under the Tax Cuts and Jobs Act, for passenger automobiles placed in service after Dec. 31, 2017, in tax years ending after that date, the maximum amount of regular allowable depreciation is increased substantially. The regular allowable depreciation amount is the maximum available if the taxpayer either elects out of additional first-year depreciation deduction under Code Sec. 168(k) for 5-year MACRS property, or is not eligible to claim bonus depreciation.
Annual regular allowable depreciation deductions for passenger autos under the new law are limited as follows
- First (placed-in-service) year, lesser of 20% or $10,000.
- Second year, 32% or $16,000.
- Third year, 19.2% or $9,600.
- Fourth year, 11.52% or $5,760.
- Fifth year, 11.52% or $5,760.
- Sixth year, 5.76% or $5,760. (Code Sec. 280F(a))
For passenger automobiles placed in service after 2018, these dollar limits will be indexed for inflation. (Code Sec. 280F(d)(7))
Observation: Presumably IRS will continue using a different CPI component in determining annual dollar caps for light trucks and vans placed in service after 2018.
Observation: The higher limits will more truly restrict the effect of the dollar caps to “luxury autos”. For example, an auto placed in service in 2017 and not eligible for bonus depreciation is subject to the first-year auto dollar cap if it cost more than $15,800 (20% of that figure is $3,160) —hardly a luxury auto. Under the new law, an auto placed in service in 2018 that either is not eligible for bonus depreciation, or which is subject to an election out of bonus depreciation, doesn’t become subject to the first year auto dollar cap until its cost exceeds $50,000 (20% of that figure is $10,000).
Luxury Auto Dollar Cap for Bonus-Depreciation-Eligible Business Autos
Bonus first-year depreciation under Code Sec. 168(k), which was originally designed to act as an economic stimulus in the wake of the Sept. 11, 2001, terrorist attacks, has lived on as a way for Congress to stimulate investment in business machinery and investment. The bonus first year percentage has varied between 30%, 40%, 50% and 100%, depending on the tax year. In general, the bonus first-year depreciation allowance is found by multiplying the qualifying asset’s unadjusted depreciable basis by the appropriate percentage. Where the bonus depreciation percentage is less than 100%, a taxpayer calculates its regular depreciation allowance for the first and subsequent years by subtracting the bonus first year depreciation amount from the unadjusted depreciable basis of the asset.
In general, the bonus depreciation percentage was 50% for qualifying assets placed in service after Dec. 31, 2007 and before Sept. 28, 2017. The Tax Cuts and Jobs Act boosted that percentage to 100%, effective generally for qualifying property placed in service after Sept. 27, 2017, and before Jan. 1, 2023, and made other liberalizations, including permitting used property to qualify for bonus depreciation if certain conditions are met.
An increase in the first-year depreciation dollar cap applies to autos (including light duty trucks and vans) that are subject to the Code Sec. 280F luxury auto dollar limits and the bonus first-year depreciation allowance under Code Sec. 168(k). This increase was $8,000 under pre-Tax Cuts and Jobs Act law, and, under the Act, remains at that level through 2026.
Observation: In essence, the $8,000 boost in the first-year dollar cap is the luxury auto owner’s capped allowance for bonus depreciation.
Illustration 1 In February of 2018, a business buys and places in service a new $50,000 production machine. It also buys a new $50,000 auto that is used 100% for business by its chief of sales. Under the bonus depreciation rules, the business may write off the entire $50,000 cost of the machine in 2018, but it can deduct no more than $18,000 of the cost of the auto in that year ($10,000 regular luxury auto first-year dollar cap plus $8,000).
Observation: Under the Tax Cuts and Jobs Act, business auto buyers will be saddled with a strange problem, and a complex computational workaround, if IRS adopts the same approach it took for luxury autos when the first-year bonus depreciation was last pegged at 100% (generally for property acquired after Sept. 8, 2010, and placed in service before Jan. 1, 2011).
The problem surfaces in tax years after the placed-in-service year. Rev Proc 2011-16, 2011-16 IRB 664, provides that if the unadjusted depreciable basis (i.e., basis for gain or loss before depreciation adjustments) of a passenger auto that is qualified property eligible for the 100% additional first-year depreciation deduction exceeds the first-year luxury auto limit, the excess amount is the unrecovered basis of the passenger automobile for purposes of Code Sec. 280F(a)(1)(B)(i), and, therefore, is treated as a deductible expense in the first tax year succeeding the end of the normal 5-year (effectively 6-year) recovery period subject to the dollar limitation under Code Sec. 280F(a)(1)(B)(ii) ($5,760 under the Tax Cuts and Jobs Act).
Observation: In essence, if IRS applies the same logic this year as it did in Rev Proc 2011-16, unless there’s an election out of 100% bonus first-year depreciation for 5-year MACRS property, a taxpayer that buys and places in service an auto after Dec. 31, 2007, and before Jan. 1, 2023, has effectively claimed a 100% first-year depreciation deduction for it in the first year, even though the bonus depreciation allowance is capped under Code Sec. 168(k)(2). Thus, applying the normal business-auto depreciation rules for years 2 through 6 yields a zero deduction.
Illustration 2 A taxpayer buys a $50,000 car in 2018 and uses it entirely for business. The car is eligible for bonus depreciation, and the taxpayer does not elect out of Code Sec. 168(k) for equipment purchases (including autos and trucks) in the 5-year MACRS class. Under the luxury auto rules, its depreciation deduction for 2018 is capped at $18,000 ($10,000 regular first year luxury auto cap plus $8,000). If IRS takes the same approach under the Tax Cuts and Jobs Act as it did in Rev Proc 2011-16, the taxpayer may not claim any depreciation deductions for the auto in tax years 2019 through 2023 (years 2 through 6 of ownership), and the excess amount of $32,000 ($50,000 minus $18,000) would be recovered by the taxpayer beginning in tax year 2024 (if the taxpayer still owned the car at that point!) subject to a $5,760 annual dollar cap.
Under Rev Proc 2011-16, IRS mitigated this strange result for business auto owners by, in essence, allowing the business auto owner to make an election to be deemed to have claimed 50% (and not 100%) bonus depreciation for every cost-recovery purpose other than computing the first-year’s write-off.
Observation: Under Code Sec. 168(k)(10), a taxpayer that places in service qualified (i.e., bonus-depreciation-eligible) property during the first tax year ending after Sept. 27, 2017, can make an actual election (as opposed to a deemed election), to “step down” from 100% to 50% bonus depreciation for assets in a particular class. However, keep in mind that an actual step-down election for a particular class of property—such as the 5-year MACRS class that includes cars and trucks—would apply to all assets in that class placed in service in the year for which the election is made. This shouldn’t be an impediment for businesses that don’t have large capital outlays, as the other (non-luxury-auto) 5-year MACRS property it buys could be expensed under the liberalized Code Sec. 179 rules.
Recommendation: As explained in Part II of this article, if the taxpayer is contemplating the purchase of a larger vehicle, one way to entirely avoid potential headaches associated with the confluence of the 100% first-year bonus depreciation rules and the luxury auto rules is to buy a heavy SUV—one with a loaded GVW rating of more than 6,000 pounds.
Recommendation: One other sure-fire way around the problems posited by Rev Proc 2011-26 is to lease business autos instead of purchasing them. As explained in Part II of this article, the business use percentage of the lease cost, net of a usually modest lease income inclusion amount from an IRS table, will be deductible
Source: Thomson Reuters Checkpoint Newsstand 2/23/18