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Despite
the increased amounts that may be written off as Section 179 expenses
or claimed as first-year bonus depreciation, a cap remains on all
amounts that may be deducted for business vehicles.
Spring 2003's Jobs and
Growth Tax Relief Reconciliation Act (JGTRRA) certainly contained
a unique loophole that - in essence - meant that Uncle Sam would pick
up as much as $100,000 of the cost of a large sport utility vehicle
(SUV) purchased for business use. Only recently, however, have the
tax authorities acknowledged that it is not always possible for
contractors to fully recover the cost of vans and light trucks.
New temporary rules have been put in place that will help alleviate
this problem. The Internal Revenue Service (IRS) also has published
new guidelines to help ease any change in use of business vehicles.
The Write-Off Limits
Under our tax rules, tax
deductions permit many contractors to fully recover the cost of
a basic automobile used in the business within a five-year period.
In reality, however, many contractors have long been aware that
an operation with a valid business need for a van or a light truck
cannot recover its cost within that five-year period, and only recently
did the IRS recognize that these vehicles generally cost more than
other passenger automobiles yet still are subject to the same so-called
luxury-car depreciation limits.
Unfortunately
lawmakers have not given the IRS the authority to simply raise the
limits for deductions on van and light-truck costs, a raise that
would reflect their higher costs. The IRS will, however,
issue inflation-adjusted dollar limits for vehicles placed in service
in 2003. Those inflation-adjusted dollar limits will reflect a higher
rate of price inflation for vans and light trucks.
This action, combined with
the substantial increase in first-year depreciation limits under
the recent tax-cut bills for all new passenger automobiles - including
vans and light trucks - will provide some relief. Thus, a contractor
electing the 50% additional first-year depreciation permitted under
JGTRRA can recover the full cost - nearly $23,000 over the five-year
recovery period - of a new automobile.
What's more, the IRS and
the United States Department of the Treasury have concluded that
a limited exclusion from the luxury-tax definition of passenger
automobiles for any truck or van may be warranted - as long as it
is based on objective factors and does not provide an incentive
to purchase a truck or a van when a less expensive automobile could
fulfill a business need. In other words, in addition to adjusting
the inflation price figures soon to be released, the IRS has issued
a limited exclusion from the luxury-car deduction cap for vans and
light trucks used by many businesses.
Necessity,
Not Luxury
Although they seek comments
from the public on these proposed new exclusions for vans and light
trucks, the temporary regulations will exclude from the definition
of passenger automobiles any truck or van that is a qualified, nonpersonal-use
vehicle. Qualified, nonpersonal-use vehicles include basic light
trucks and vans. Also included are trucks and vans that have been
modified specially by installing permanent shelving or by painting
the vehicle to display advertising or a company's name so they are
unlikely to be used more than minimally for personal purposes.
According to the IRS, these
specially manufactured or modified vehicles do not provide significant
elements of personal benefit. Few grading and excavating contractors
are likely to purchase these vehicles unless motivated by a valid
business purpose that could not be met with a less expensive vehicle.
The Loophole
To qualify for the JGTRRA
tax breaks, an SUV must have been placed in business service after
December 31, 2002, and must have a loaded gross vehicle weight (i.e.,
maximum total weight of a loaded vehicle as specified by the manufacturer)
of more than 6,000 lb. Automobiles also can qualify, provided that
their curb weight exceeds 6,000 lb. Otherwise the maximum depreciation
write-off for cars for the first year under the revised tax rules
is $7,650.
The maximum dollar amount
that may be deducted under Section 179 has been increased from $25,000
to $100,000 for qualifying property placed in service between December
31, 2002, and December 31, 2005. The Section 179 ceiling also has
been increased from $200,000 to $400,000. Deductions for Section
179 expenditures exceeding that $400,000 ceiling will be reduced,
dollar for dollar. Naturally this unique deduction for SUVs or any
Section 179 expenses cannot exceed the income of the earthmoving
operation.
The Rules
Automobiles and other forms
of transportation our lawmakers believe lend themselves to personal
use, such as airplanes, trucks, and boats, are considered "listed"
property. For listed property, unless it is used more than 50% for
business, the depreciation deductions are restricted. Vehicles labeled
as passenger automobiles might be used more than 50% for business
purposes; however, there are further limits on the annual depreciation
that may be claimed for them.
These luxury-car limits
are based on 100% business use. Naturally, if business use is less
than 100%, the limits must be reduced to reflect the actual business-use
percentage.
When it comes to the luxury-car
caps, a passenger automobile is defined as any four-wheeled vehicle
manufactured primarily for use on public streets, roads, and highways
that has an unloaded gross vehicle weight of 6,000 lb. or less.
Trucks and vans - including SUVs and minivans - have, until now, been
treated as passenger automobiles if they have a gross vehicle weight
of 6,000 lb. or less.
Making Changes
In a related area, a company
car may be converted for personal use, or a personal vehicle may
be converted into a depreciable business asset. In fact, the use
of property may change from use in a for-profit earthmoving business
to use in overseas operations or on a project financed by tax-exempt
bonds.
The IRS has proposed regulations
that would create guidelines for determining the annual depreciation
allowance for any vehicles or property for which the use changes.
Changes in use include a conversion of personal-use property to
a business or income-producing use, a conversion of depreciable
property to personal-use property, and a change that results in
a different recovery period, a different depreciation method, or
both.
Generally the proposed
regulations require personal-use property converted to business
or income-producing use to be treated as having been placed in service
by the contractor on the date of the conversion. The amount depreciated - the
property's "basis" - is the lesser of its fair market value or adjusted
depreciable basis at the time of the conversion.
A conversion of a vehicle
or other property from business or income-producing use to personal
use is treated as a disposition of the property. Of course, no gain,
loss, or recapture of previously claimed depreciation is recognized
as a result of the conversion.
A change in the use of
depreciable property also can occur when a taxpayer begins or ceases
to use the property predominantly outside the US, when the property
changes to tax-exempt bond-financed property, or when the property
changes to or from tax-exempt-use property.
Until these rules are adopted
or finalized, all changes in use for depreciable property after
December 31, 1986, will be treated as having occurred on the first
day of the year of change and may be reported using any reasonable
depreciation method, as long as it is consistently applied.
Finally
Only in the eyes of lawmakers
could the vans and light trucks used in many earthmoving businesses
be considered luxury vehicles suitable for personal use. At last
the IRS has acknowledged that deduction caps prevent many from recovering
the full cost of vans and light trucks.
Changes in inflation prices,
according to the IRS, soon will help relieve this situation, as
will a limited exemption from the luxury-car category. These temporary
regulations shortly will become final, but will your grading and
excavation business take advantage of them and take the first steps
to fully recover the costs of its earthmoving vans and light trucks?
Guest
author Mark E. Battersby is a financial and tax consultant based
in Ardmore, PA.
GEC
- March/April 2004
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