Depreciation For 2008 Flexible, Allows For Unique Tax-Planning

By Jane Fyksen Crops Editor
Friday, December 5, 2008 3:24 PM CST

First in a series

It’s the time of year crop producers turn their attention to other ground, namely taxes and desk-work that may have piled up faster than corn in a bin while they’ve harvested and tried to get a jump on next spring.

There are some big tax changes for 2008 including a new requirement that purchases of depreciable equipment be identified as new or used. The direct expensing maximum limit also increased to $250,000 for tax years beginning in 2008; it had been $125,000 for 2007.

In addition to a check in the mail or electronic transfer of funds, the Economic Stimulus Act of 2008 also changes some depreciation rules that may affect producers’ tax planning and record keeping before tax time - and make a substantial difference in your 2008 income taxes, says Michigan State University Extension Educator Larry Borton.

He says depreciation for 2008 is tremendously flexible and allows for some unique tax planning.

“On your 2008 depreciation schedule, it will be important to specify whether purchased depreciable property is new or used; it can make a large difference in the amount of 2008 additional first-year depreciation that is required by the new law,” he reports.

Direct expensing allows an expense deduction in the year of purchase for costs that normally must be deducted or depreciated over many years. The direct expensing maximum limited increased to $250,000 for tax years beginning in 2008. (It had been $125,000 in 2007.) Eligible property includes pickups over 6,000 Gross Vehicle Weight Rating, farm machinery, single-purpose livestock or greenhouse structures and drainage tile.

If a new combine costs $300,000, a grower could direct expense $250,000, leaving $50,000 for normal depreciation.

The $250,000 limit beings phasing out at $800,000 of eligible property purchases placed in service during the tax year. Each dollar of purchases above $800,000 decreases the amount by one dollar. If $1 million in qualified property is placed in service, the direct expensing limit is reduced by $200,000 ($1 million minus $800,000), resulting in a limit of $50,000 ($250,000 minus $200,000), says Borton, who also manages the MSU Telfarm financial recordkeeping system.

“For many farm businesses, direct expensing may provide adequate deductions when added to normal depreciation. But for large farms or those that have deferred income in past years, addition depreciation is available for 2008,” he points out.

After direct expensing deductions are taken, an additional 50 percent bonus depreciation is required in 2008 for new property n but not used n for which Modified Accelerated Cost Recovery system (MACRS) applies and which have a class life of 20 years or less. “This includes most depreciable farm property,” he notes.

That new $300,000 combine could have $50,000 of cost left to depreciate after the expense election of $250,000. Bonus depreciation is 50 percent of the remaining cost of $50,000, or $25,000. That leaves $25,000 to depreciate under normal methods. Using IRS depreciation tables for 150 percent declining balance for seven-year property, the first-year deduction for $25,000 amounts to $2,678. The $300,000 combine is allowed a first-year total maximum depreciation of $277,678 ($250,000 direct expensing plus $25,000 bonus, plus $2,678 regular). That leaves only $22,322 to depreciate in future years. Borton says there’s no phase-out of bonus depreciation with an upper limit on qualifying investment property as there is with direct expensing.

“Another difference between direct expensing and bonus depreciation involves trade-ins,” he notes. If an old skid steer loader with a remaining basis (i.e. the amount still left on the depreciation schedule) of $10,000 is traded in, and $15,000 cash is paid on a new one, only direct expensing of the “boot” (i.e. cash) paid ($15,000) is permitted, he says.

In contrast, bonus depreciation of $12,500 is allowed on the total of the carryover basis of $10,000, plus the boot of $15,000 (50 percent of $25,000).

“Note that the amount allowed on the trade-in by the machinery dealer has absolutely nothing to do with the amount of direct expensing or bonus depreciation,” Borton says.

He mentions there are unique situations with rules that differ from the general rule of 50 percent bonus depreciation. A new passenger car used 100 percent for business is limited to an extra $8,000 of depreciation the first year for bonus depreciation, rather than 50 percent of the cost. The amount can be added to the $2,960 normally allowed for 2008 first-year automobile depreciation for a total limit of $10,960.

The IRS allows a taxpayer to elect out of the required 50 percent bonus depreciation by property class (i.e. three-year, five-year, seven-year, 10-year, 15-year or 20-year). Borton says, for instance, that 50 percent bonus depreciation could be used for a dairy barn (10-year) and a farmer could still elect out for his farm machinery (seven-year). But all new property within the same class must be treated the same.

“The IRS has said that guidance on the 2004 special depreciation will be similar to this bonus depreciation,” says Borton. “The 50 percent bonus depreciation allowance only applies for property purchased and placed into service after Dec. 31, 2007 and before Jan. 1, 2009, which means it only applies in 2008.” Bonus depreciation applies for both regular income tax and the alternative minimum tax.

If a farm business is required to use the Alternate Depreciation System (ADS), bonus depreciation isn’t allowed. If, however, a farm business elected to use ADS, then bonus depreciation may be used.

Borton mentions that most orchard or vineyard owners can’t use bonus depreciation on any farm business they operate because they probably elected out of the uniform capitalization rules and therefore must use ADS.

“This system uses the straight line method and usually has a longer class life. Direct expensing is still allowed. Listed property used 50 percent or less for business - an automobile might be 50 percent personal use - must use ADS and isn’t eligible for bonus depreciation, and is also not eligible for direct expensing,” he adds.

Borton says a strategy to maximize depreciation in 2008 would include using direct expensing for eligible used property, using any remaining direct expense allowance expensing for new property, and then using the 50 percent bonus depreciation on all the new property cost that’s left.

“Whatever basis or cost remaining then gets normal depreciation treatment,” he remarks.

“Order makes a difference on property,” he mentions. “The direct expensing is taken first, then 50 percent bonus is taken, and finally normal depreciation on the rest.”

Borton tells growers to first note whether purchased depreciable items are new or used. Remember the direct expensing maximum limit is $250,000 in 2008. Finally, 50 percent bonus depreciation is required on new purchases unless electing out of it by class.

“I never recommend business purchases of items just for tax purposes, but I do recommend using tax laws so that no more taxes than necessary are paid,” he concludes, stressing these rules are complicated and IRS has further guidance at www.irs.gov.

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