Equipment Leasing

<div class="Section1">Yes, the &ldquo;at risk&rdquo; rules will apply unless the investment is in an entity taxed as a C corporation, other than a closely-held corporation (generally, more than 50 percent control by 5 or fewer owners). The &ldquo;at risk&rdquo; rules will not apply to a closely-held corporation&rsquo;s equipment leasing activities if 50 percent or more of the corporation&rsquo;s gross receipts are attributable to equipment leasing<a href="#_ftn1" name="_ftnref1">¹</a> (see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="8004">8004</a>).<div class="Section1"><br /> <br /> In general, the &ldquo;at risk&rdquo; rules limit the deduction an investor may claim for the investor&rsquo;s share of net losses generated by an equipment leasing program to the amount he or she has at risk in that program. The rules do not prohibit an investor from offsetting his or her share of the deductions generated by the program against the income received from that program. For a detailed explanation of the operation of the at risk limitation, see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="8006">8006</a> to Q <a href="javascript:void(0)" class="accordion-cross-reference" id="8009">8009</a>.<br /> <br /> Put as simply as possible, an investor is initially &ldquo;at risk&rdquo; to the extent that the investor is not protected against the loss of money or other property he or she contributes to the program. For the specifics as to how an investor&rsquo;s &ldquo;amount at risk&rdquo; is calculated, see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="8005">8005</a>.<br /> <br /> </div><div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>. See IRC &sect;&sect; 465(a)(1), 465(c)(4).<br /> <br /> </div></div><br />

<div class="Section1">Cash basis taxpayers generally include rental payments in income in the taxable year in which they are actually or constructively received. Leasing programs have sometimes used deferred or stepped rent schedules in order to delay receipt of income until later years of the program, with the effect of increasing loss deductions in early years. However, lessors under certain deferred or stepped payment lease agreements entered into after June 8, 1984, are required to report rental income as it accrues, as well as interest on rent accrued but unpaid.<a href="#_ftn1" name="_ftnref1">¹</a> Agreements are subject to this rule if at least one amount allocable to the use of the property during a calendar year is to be paid after the close of the following calendar year, or if there are increases in the amount to be paid as rent under the agreement. This accrual requirement does not apply if the aggregate value of the money and other property received and to be received for use of the property is $250,000 or less.<a href="#_ftn2" name="_ftnref2">²</a> These rules are discussed in further detail in Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7831">7831</a>.<div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>. IRC &sect; 467(a).<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>. IRC &sect; 467(d).<br /> <br /> </div></div><br />

<div class="Section1">The investor may have the following adjustments to alternative minimum taxable income (AMTI) or tax preferences in connection with investment in an equipment leasing program that passes losses and deductions through to the investor:<br /> <p style="padding-left: 40px">(1) Passive activity losses (determined by taking into account the adjustments to AMTI and tax preferences) are not allowed in calculating AMTI.<a href="#_ftn1" name="_ftnref1">¹</a></p><br /> <p style="padding-left: 40px">(2) Generally, in calculating AMTI, equipment must be depreciated using a 150 percent declining balance method switching to the straight-line method at a time to maximize the deduction over the regular recovery periods.</p><br /> Property is assigned to various <em>class lives</em> in Revenue Procedure 882.<a href="#_ftn2" name="_ftnref2">²</a> These class lives can also be found in IRS Publication 946.<br /> <br /> <div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>. IRC &sect; 58(b).<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>. 1988-1 CB 785.<br /> <br /> </div></div><br />

<div class="Section1"><br /> <br /> Yes, rental activities will generally be considered passive activities subject to the passive loss rules. Even if substantial services are provided, so that the equipment leasing activity is not considered a rental activity, the investor usually will not materially participate in the program. As a result, the investor in such a program will generally be subject to the passive loss rules (see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="8010">8010</a> to Q <a href="javascript:void(0)" class="accordion-cross-reference" id="8021">8021</a>). However, an entity taxed as a C corporation typically is not subject to the passive loss rules (see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="8010">8010</a>).<br /> <br /> In general, the rules limit the amount of the taxpayer&rsquo;s aggregate deductions from all passive activities to the amount of aggregate income from all passive activities; passive credits can be taken against only tax attributable to passive activities. The rules are applied separately in the case of a publicly traded partnership; aggregation is permitted only within the partnership. The rules are intended to prevent taxpayers from offsetting salaries, interest, dividends, and other positive income with losses from passive activities. The benefit of the disallowed passive losses and credits is not altogether lost, but rather is postponed until such time as the taxpayer has additional passive income or disposes of the activity (see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="8010">8010</a> to Q <a href="javascript:void(0)" class="accordion-cross-reference" id="8021">8021</a>).<br /> <br /> </div><br />

<div class="Section1"><br /> <br /> The amount realized on the sale or other disposition of property in excess of adjusted basis is gain; if the amount realized is less than adjusted basis, it is loss.<a href="#_ftn1" name="_ftnref1">¹</a> The basis of property is generally its cost reduced by the portion of cost which the taxpayer elects to treat as an expense (see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7895">7895</a>) and by the basis adjustment attributable to any investment tax credit (see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7894">7894</a>).<a href="#_ftn2" name="_ftnref2">²</a> Also, the basis is reduced each year by the amount of the depreciation taken so that the <em>adjusted</em> basis in the property reflects accumulated depreciation deductions. If depreciation is not deducted, the basis must nonetheless be reduced by the amount of depreciation allowable.<a href="#_ftn3" name="_ftnref3">³</a> If the investment tax credit is recaptured in connection with property as to which a basis adjustment was required, then the basis is increased by such recaptured amount.<a href="#_ftn4" name="_ftnref4">⁴</a><br /> <br /> Where leased equipment has been depreciated, gain on the sale of the property must be treated as ordinary income to the extent of all depreciation deductions allowed.<a href="#_ftn5" name="_ftnref5">⁵</a> The gain in excess of the recaptured ordinary income is &ldquo;IRC Section 1231&rdquo; gain; loss is &ldquo;IRC Section 1231&rdquo; loss. See Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7834">7834</a> for an explanation of the treatment of IRC Section 1231 gains and losses. See Q <a href="javascript:void(0)" class="accordion-cross-reference" id="667">667</a> if the equipment is sold on the installment method.<br /> <br /> <div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>. IRC &sect; 1001.<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>. IRC &sect;&sect; 1012, 1016(a).<br /> <br /> <a href="#_ftnref3" name="_ftn3">3</a>. IRC &sect; 1016(a).<br /> <br /> <a href="#_ftnref4" name="_ftn4">4</a>. IRC &sect; 50(c)(2).<br /> <br /> <a href="#_ftnref5" name="_ftn5">5</a>. IRC &sect; 1245.<br /> <br /> </div></div><br />

<div class="Section1"><br /> <br /> Property leased to certain tax-exempt entities (tax-exempt use property) may not, in general, use the normal recovery periods and percentages.<a href="#_ftn1" name="_ftnref1">¹</a><br /> <br /> A tax-exempt entity includes the following:<br /> <p style="padding-left: 40px">(1) the United States, any State or political subdivision thereof, or any agency or instrumentality of any of the above;</p><br /> <p style="padding-left: 40px">(2) an organization (other than a farmers&rsquo; cooperative) that is exempt from normal income tax;</p><br /> <p style="padding-left: 40px">(3) any foreign person or entity; and</p><br /> <p style="padding-left: 40px">(4) certain Native American tribal governments.<a href="#_ftn2" name="_ftnref2">²</a></p><br /> The deduction for tax-exempt use property is determined by using a straight line method over the recovery period. The recovery period is the greater of the present class life (or 12 years for personal property with no present class life) or 125 percent of the lease term.<a href="#_ftn3" name="_ftnref3">³</a> Property is assigned to various class lives for purposes of depreciation in Revenue Procedure 87-56.<a href="#_ftn4" name="_ftnref4">⁴</a> Options to renew and successive leases may be aggregated with the original lease term for this purpose.<a href="#_ftn5" name="_ftnref5">⁵</a><br /> <br /> Property is not tax-exempt use property if the tax-exempt entity uses it predominantly in an unrelated trade or business that is subject to income tax.<a href="#_ftn6" name="_ftnref6">⁶</a> Property is considered used predominantly in an unrelated trade or business if it is used in the unrelated trade or business more than 50 percent of the time it is used during a taxable year. If only a portion of the property is used in an unrelated trade or business, the remainder may be tax-exempt use property.<a href="#_ftn7" name="_ftnref7">⁷</a> Property leased to a foreign person or entity is not considered tax-exempt use property if more than 50 percent of the foreign person or entity&rsquo;s gross income is subject to United States income tax.<a href="#_ftn8" name="_ftnref8">⁸</a><br /> <br /> Property subject to a short-term lease is not treated as tax-exempt use property. A short-term lease is a lease that is for a term which is less than three years, and (if the leased property has a class life) less than the greater of 1 year or 30 percent of the property&rsquo;s class life.<a href="#_ftn9" name="_ftnref9">⁹</a> The Internal Revenue Service may aggregate options to renew and successive leases with the original lease term for this purpose. The Tax Court has held that a lease term is determined by the &ldquo;realistic contemplation of the parties at the time the property is first put into service.&rdquo;<a href="#_ftn10" name="_ftnref10">¹⁰</a><br /> <br /> Informal agreements to extend a lease term are included with the original lease term. Options to renew possessed by the lessor or lessee are included in the original lease term, whether exercised or not. Successive leases entered into at the same time concerning the same or substantially similar property may be treated as one lease. The leases will not be aggregated merely because the lessor and lessee entered into a new lease at fair market rental value at the end of the original lease term.<a href="#_ftn11" name="_ftnref11">¹¹</a><br /> <br /> For leases entered into after April 19, 1995, an additional time during which the lessee may not be the lessee will nevertheless be included in the lease term if the lessee (or a related person) retains an obligation to pay rent or make a payment in the nature of rent with respect to such period. A payment in the nature of rent is a payment intended to substitute for rent or to pay or supplement the rental payments of another. For example, a payment in the nature of rent includes payments required to be made for such other period if (1) the leased property is not leased; (2) the leased property is leased for terms that do not meet certain conditions; or (3) there is a failure to pay rent. In addition, for leases entered into after April 25, 1996, if property is subject to one or more leases (including subleases) entered into as part of one transaction (or series of related transactions), the lease term includes all periods described in any of such leases.<a href="#_ftn12" name="_ftnref12">¹²</a> No inference is intended with respect to leases entered into prior to such dates.<a href="#_ftn13" name="_ftnref13">¹³</a><br /> <br /> For transfers made after April 19, 1995, if tax-exempt use property is transferred (directly or indirectly) in a like-kind exchange under IRC Section 1031 (see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="710">710</a>) among related persons and a principal purpose of the transfer or any related transaction is to avoid or limit the application of the alternative depreciation system for tax-exempt use property, property received in exchange for tax-exempt use property (tainted property) must be depreciated under the alternative depreciation system for tax-exempt use property using the same methods and periods previously used for the transferred tax-exempt property. Generally, this rule applies to the extent the basis of the tainted property does not exceed the basis of the transferred tax-exempt use property.<a href="#_ftn14" name="_ftnref14">¹⁴</a> No inference is intended with respect to transfers prior to such date.<a href="#_ftn15" name="_ftnref15">¹⁵</a><br /> <br /> Deductions related to tax-exempt use property may be further limited to the amount of income from the property.<a href="#_ftn16" name="_ftnref16">¹⁶</a><br /> <br /> <div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>. IRC &sect;&sect; 168(g)(1)(B), 168(h).<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>. IRC &sect; 168(h)(2).<br /> <br /> <a href="#_ftnref3" name="_ftn3">3</a>. IRC &sect;&sect; 168(g)(2), 168(g)(3).<br /> <br /> <a href="#_ftnref4" name="_ftn4">4</a>. 1987 CB 674 (Rev. Proc. 83-35, 1983-1 CB 745, for property placed in service before 1987).<br /> <br /> <a href="#_ftnref5" name="_ftn5">5</a>. IRC &sect; 168(i)(3)(A).<br /> <br /> <a href="#_ftnref6" name="_ftn6">6</a>. IRC &sect; 168(h)(1)(D).<br /> <br /> <a href="#_ftnref7" name="_ftn7">7</a>. Temp. Treas. Reg. &sect; 1.168(j)-1T(A-8).<br /> <br /> <a href="#_ftnref8" name="_ftn8">8</a>. IRC &sect; 168(h)(2)(B).<br /> <br /> <a href="#_ftnref9" name="_ftn9">9</a>. IRC &sect; 168(h)(1)(C).<br /> <br /> <a href="#_ftnref10" name="_ftn10">10</a>. Temp. Treas. Reg. &sect; 1.168(j)-1T(A-17), adopting <em>Hokanson v. Comm.</em>, 730 F.2d 1245, 84-1 USTC &para;9217 (9th Cir. 1984).<br /> <br /> <a href="#_ftnref11" name="_ftn11">11</a>. Temp. Treas. Reg. &sect; 1.168(j)-1T(A-17).<br /> <br /> <a href="#_ftnref12" name="_ftn12">12</a>. Treas. Reg. &sect; 1.168(i).<br /> <br /> <a href="#_ftnref13" name="_ftn13">13</a>. TD 8667, 1996-1 CB 22.<br /> <br /> <a href="#_ftnref14" name="_ftn14">14</a>. Treas. Reg. &sect; 1.168(h)-1.<br /> <br /> <a href="#_ftnref15" name="_ftn15">15</a>. TD 8667, 1996-1 CB 22.<br /> <br /> <a href="#_ftnref16" name="_ftn16">16</a>. See IRC &sect; 470.<br /> <br /> </div></div><br />

<div class="Section1"><br /> <br /> <em>Editor&rsquo;s Note:</em> The 2017 tax reform legislation extended the bonus depreciation provisions through the 2026 tax year. However, the provision was modified so bonus depreciation will be gradually phased out from 2018026.<br /> <br /> In determining the income or loss from the activity, an owner of leased equipment placed in service after 1980 may deduct its cost over a period of years&ndash;generally three, five, or seven years depending on the kind of equipment. (See Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7891">7891</a> concerning the ownership of leased property.) For property placed in service after 1986, the amount of the deduction is generally determined by applying a declining balance method to the basis of the property<a href="#_ftn1" name="_ftnref1">¹</a> (see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="716">716</a>). Normally, the initial basis of the property is its cost. For property placed in service after 1981 and before 1987, the amount of the deduction was a percentage of the &ldquo;unadjusted basis,&rdquo; generally, the cost of the property.<a href="#_ftn2" name="_ftnref2">²</a> (For property placed in service after 1986, the Service has published tables that were prepared using the appropriate declining balance method, but that provide percentage figures to be applied to the unadjusted basis of the property in determining each year&rsquo;s cost recovery allowance.)<a href="#_ftn3" name="_ftnref3">³</a> For the temporary rules dealing with bonus depreciation and the rules in IRC Section 179 providing an election to expense a portion of the costs of acquiring equipment, see below.<br /> <br /> Cost includes the principal amount of debt already encumbering the property or new debt incurred in acquiring the property, whether recourse or not.<a href="#_ftn4" name="_ftnref4">⁴</a> However, the debt must be bona fide; it is not included in basis if the purchase price substantially exceeds the fair market value of the property that nominally secures the liability.<a href="#_ftn5" name="_ftnref5">⁵</a> Basis for depreciation must be reduced by the portion of the basis that the taxpayer may have elected to treat as an expense (see below). The basis is further reduced by the basis adjustment attributable to the investment tax credit (see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7894">7894</a>). The basis for depreciation under the declining balance method is calculated each year as reduced by depreciation deductions allowable in previous years, while the unadjusted basis is generally determined in the first year that a property is placed in service and is not reduced by depreciation deductions.<br /> <br /> Depreciation is limited in the year in which equipment is placed in service to the portion of the year in which the equipment is considered to be held under the following <em>conventions</em>. Equipment is generally treated as placed in service on the midpoint of the year in which placed in service. However, where 40 percent of depreciable property, other than residential rental property and nonresidential real property, is placed in service during the last three months of the year, equipment placed in service during any quarter of such year is treated as placed in service on the midpoint of such quarter. Property placed in service and disposed of in the same year is not taken into account under the 40 percent test and the mid-quarter convention.<a href="#_ftn6" name="_ftnref6">⁶</a> The IRS provided relief from the mid-quarter convention if a taxpayer&rsquo;s third or fourth quarter included September 11, 2001.<a href="#_ftn7" name="_ftnref7">⁷</a><br /> <br /> The mid-quarter 40 percent test is made without regard to the length of the taxable year. Thus, if property (with exceptions, as noted in the preceding paragraph) is placed in service in a taxable year of three months or less, the mid-quarter convention applies regardless of when the property was placed in service (i.e., 100 percent of property has been placed in service in the last three months).<a href="#_ftn8" name="_ftnref8">⁸</a><br /> <br /> In the case of a short taxable year (i.e., a taxable year that is less than 12 months), the recovery allowance for equipment is determined by multiplying the deduction that would have been allowable if the recovery year were not a short taxable year by a fraction, the numerator of which equals the number of months in the short taxable year and the denominator of which is 12.<a href="#_ftn9" name="_ftnref9">⁹</a> Proposed regulations under IRC Section 168(f)(5) (as in effect prior to TRA &rsquo;86) provided that a taxable year of a person placing property in service did not include any month prior to the month in which the person began engaging in a trade or business or holding recovery property for the production of income.<a href="#_ftn10" name="_ftnref10">¹⁰</a> Presumably, this principle would continue to apply after TRA &rsquo;86.<br /> <br /> A partner who purchases an interest in a partnership after it has commenced business can deduct depreciation attributable only to the period during which he or she owns the partnership interest.<a href="#_ftn11" name="_ftnref11">¹¹</a><br /> <br /> In the first year of investment in a partnership, a partner&rsquo;s depreciation deduction is generally prorated because of (1) the partnership&rsquo;s short taxable year and (2) the rules applicable when a partner purchases an interest after the partnership commences business. As a result, an investor purchasing a partnership interest late in the year will find the first year depreciation deduction substantially limited.<br /> <br /> The inability of a partner to take a full first year depreciation deduction if he or she invests late in the year has created considerable interest in forming equipment leasing programs as grantor trusts. Since for tax purposes the investor in a grantor trust is generally treated as the owner of the investor&rsquo;s proportionate share of the property contained in the trust (under IRC Sections 671 through 679), it is reasoned that the taxable year of each investor is used to determine whether the investor can take a full year depreciation deduction on his or her proportionate share. The taxable year of the investor, for depreciation purposes, does not begin prior to the month the investor begins engaging in a trade or business or holding depreciable or recovery property for the production of income.<a href="#_ftn12" name="_ftnref12">¹²</a> If the investor engages in such activities for the full year, he or she is entitled to a full first year depreciation deduction (subject to the conventions discussed above). Otherwise, the investor is limited by a short taxable year and corresponding proration of the first year depreciation deduction. However, if the investor engages in a small amount of such activities prior to investment in the program with the purpose of obtaining disproportionately large depreciation deductions, the investor&rsquo;s taxable year (for purposes of the depreciation deduction) does not begin prior to investment in the program.<a href="#_ftn13" name="_ftnref13">¹³</a><br /> <br /> S corporations are treated like partnerships for purposes of determining the first year depreciation deduction. The first year depreciation deduction is pro-rated over the year and the deduction is taken only for depreciation allocable to the part of the year the S corporation has been in business or that a shareholder owns his or her interest. Ownership through a co-tenancy or individual ownership is treated like a grantor trust for this purpose. A full first year depreciation deduction (subject to the conventions discussed above) is available to an investor who has throughout the year engaged in a trade or business or held depreciable or recovery property for the production of income.<br /> <br /> <div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>. IRC &sect; 168(b).<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>. IRC &sect; 168(d), as in effect before the amendments made by TRA &rsquo;86.<br /> <br /> <a href="#_ftnref3" name="_ftn3">3</a>. See Rev. Proc. 87-57, 1987 CB 687.<br /> <br /> <a href="#_ftnref4" name="_ftn4">4</a>. <em>Crane v. Comm.</em>, 331 U.S. 1 (1947).<br /> <br /> <a href="#_ftnref5" name="_ftn5">5</a>. Rev. Rul. 69-77, 1969-1 CB 59; <em>Est. of Franklin v. Comm.</em>, 76 USTC &para; 9773 (9th Cir. 1976); <em>Odend&rsquo;hal v. Comm.</em>, 84 USTC &para; 9963 (4th Cir. 1984); see also <em>Prussin v. Comm.</em>, 88 USTC &para; 9601 (3d Cir. 1988), <em>nonacq</em>. AOD 1991-09.<br /> <br /> <a href="#_ftnref6" name="_ftn6">6</a>. IRC &sect; 168(d).<br /> <br /> <a href="#_ftnref7" name="_ftn7">7</a>. Notice 2001-74, 2001 CB 551.<br /> <br /> <a href="#_ftnref8" name="_ftn8">8</a>. Rev. Proc. 89-15, 1989-1 CB 816.<br /> <br /> <a href="#_ftnref9" name="_ftn9">9</a>. Rev. Proc. 89-15, 1989-1 CB 816.<br /> <br /> <a href="#_ftnref10" name="_ftn10">10</a>. Prop. Treas. Reg. &sect; 1.168(f)(4).<br /> <br /> <a href="#_ftnref11" name="_ftn11">11</a>. IRC &sect; 706(d).<br /> <br /> <a href="#_ftnref12" name="_ftn12">12</a>. Prop. Treas. Reg. &sect; 1.168(f)(4) (see above).<br /> <br /> <a href="#_ftnref13" name="_ftn13">13</a>. Prop. Treas. Reg. &sect; 1.168(f)(4) (see above).<br /> <br /> </div></div><br />

<div class="Section1">Yes. The owner of leased equipment may generally deduct each year amounts paid for interest on indebtedness incurred to purchase the equipment. The interest may be deducted only over the period to which a prepayment relates, not when prepaid.<a href="#_ftn1" name="_ftnref1">¹</a> However, the interest will generally be subject to the passive loss rules (see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7902">7902</a>).<div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>. IRC &sect;&sect; 461(g)(1), 461(h).<br /> <br /> </div></div><br />

<p> <em>Editor's Note:</em> The 2017 tax reform legislation generally allowed a 100 percent bonus depreciation for business owners with respect to property that was placed in service after September 27, 2017 and before January 1, 2023. The 2025 OBBBA restored 100 percent bonus depreciation with respect to property placed in service on or after January 20, 2025 (the 100 percent provision is permanent). Further, under the 2017 tax reform legislation, the requirement that the property be originally placed into service by the taxpayer is removed (i.e., tax reform permits accelerated expensing of used assets, <i>see</i> Q <a href="https://www.thinkadvisor.com/tax-facts/2024/06/14/721-there-any-situations-where-a-taxpayer-can-now-claim-bonus-depreciation-with-respect-to-used-property-in-which-the-taxpayer-previously-held-an-interest-how-do-the-bonus-depreciation-rules-apply-t/">721</a>).<a href="#_ftn1">¹</a></p><p> In TRA 2010, Congress provided for 100 percent bonus depreciation (i.e., expensing the full cost) for qualified property placed in service after September 8, 2010, and before 2012.<a href="#_ftn2">²</a> (ARTA 2012 extended the placed-in-service date through 2013 for a subset of qualified property that will continue to be eligible for 100 percent bonus depreciation: certain property with a longer recovery period, transportation property, and certain aircraft.)<a href="#_ftn3">³</a> For other qualifying property placed in service after 2007 and before September 27, 2017, the bonus allowance is 50 percent (i.e., one half of the cost of the property can be deducted in the year the property is placed in service), and the rest of the cost is recovered using the otherwise applicable cost recovery method.<a href="#_ftn4">⁴</a> In the latter case, the actual deduction in the first year will thus exceed 50 percent of the property's cost: the allowance will include not only the bonus depreciation but also the appropriate percentage of the rest of the cost of the property. </p><p> The 2017 tax reform legislation once again changed the bonus depreciation rules. The bonus depreciation provisions will be phased out based upon the date the property was placed in service, as follows: </p><ul class="rte2-style-ul" id="rte-3cbe6743-dce8-11f0-b992-fd3cfe21f868"><li>Property placed in service after September 27, 2017 and before January 1, 2023: 100 percent expensing.</li><li>Property placed in service after December 31, 2022 and before January 1, 2024: 80 percent expensing.</li><li>Property placed in service after December 31, 2023 and before January 1, 2025: 60 percent expensing.</li><li>Property placed in service after December 31, 2024 and before January 1, 2026: 40 percent expensing.</li><li>Property placed in service after December 31, 2025 and before January 1, 2027: 20 percent expensing.</li><li>2027 and thereafter: 0 percent expensing.<a href="#_ftn5">⁵</a></li></ul><p> In the case of qualified property acquired by the taxpayer <em>before</em> September 28, 2017, and placed in service by the taxpayer <em>after</em> September 27, 2017, different rules apply. If the property was placed in service before January 1, 2018, 50 percent expensing applies. If the property was placed in service in 2018, 40 percent expensing applies. If the property was placed in service in 2019, 30 percent expensing applies, and if the property was placed in service after 2019, 0 percent expensing is permitted.<a href="#_ftn6">⁶</a></p><p> For qualified property first placed into service by the taxpayer during the first taxable year ending after September 27, 2017, the taxpayer can elect to have 50 percent apply instead of the relevant percentage applicable to the year in question.<a href="#_ftn7">⁷</a></p><p><strong>Election to Expense</strong></p><p> Bonus depreciation provisions have typically been enacted only during economically difficult times, and for short periods. In one form or another, however, IRC Section 179 has been around for a long time. Under that provision, a limited amount of the cost to acquire equipment can be expensed in the year when the equipment is first placed in service.<a href="#_ftn8">⁸</a> In the case of partnerships and S corporations, the election to expense a portion of capital costs is made at the partnership or S corporation level.<a href="#_ftn9">⁹</a> The deduction can apply to several pieces of property used in the active conduct of the trade or business.</p><p> Recent legislation has raised the dollar amount that can be expensed for property based on the date it was placed in service. The 2025 OBBBA raised the applicable dollar thresholds. For 2025, the law increased the IRC Section 179 deduction cap from $1 million to $2.5 million for property placed in service after December 31, 2024. Phase-outs under Section 179 will now begin at $4 million starting in 2025 under the OBBBA. </p><p>The 2017 TCJA had initially increased the maximum amount that can be expensed during the tax year to $1,000,000,<a href="#_ftn10">¹⁰</a> and increased the phase-out threshold amount from $2,000,000 to $2,500,000.<a href="#_ftn11">¹¹</a> These amounts are indexed for inflation to $2,560,000 to $4,090,000 in 2026, $1,250,000 and $3,130,000 in 2025, $1,220,000 and $3,050,000 in 2024, $1,160,000 and $2,890,000 in 2023, $1,080,000 and $2,700,000 in 2022 and $1,050,000 and $2,620,000 in 2021).<a href="#_ftn12">¹²</a></p><p>The aggregate cost deductible for 2010 and thereafter was $500,000 (to be indexed for inflation; the amount for 2017 was $510,000). The annual dollar limitation was reduced by one dollar for each dollar of such investment above $800,000 for 2008 and 2009, above $2 million for 2010 and thereafter (as indexed).<a href="#_ftn13">¹³</a>In 2017, the $2 million amount was indexed to $2,030,000 ($2,010,000 in 2016).<a href="#_ftn14">¹⁴</a></p><p>Under the Protecting Americans from Tax Hikes Act of 2015 (PATH)), the aggregate cost deductible for 2008 and 2009 could not exceed $250,000.<a href="#_ftn15">¹⁵</a></p><p> The amount expensed is limited to the aggregate amount of taxable income derived from the active conduct of any trade or business of the taxpayer. An amount that is not deductible because it exceeds the aggregate income from any trade or business may be carried over and taken in a subsequent year. The amount carried over that may be taken in a subsequent year is the lesser of (1) the amounts disallowed because of the taxable income limitation in all prior taxable years (reduced by any carryover deductions in previous taxable years); or (2) the amount of unused expense allowance for such year. The amount of unused expense allowance is the excess of (1) the maximum cost of property that may be expensed taking into account the dollar and income limitations; over (2) the amount the taxpayer elects to expense.<a href="#_ftn16">¹⁶</a> Married individuals filing separately are treated as one taxpayer for purposes of determining the amount that may be expensed and the total amount of investment in such property.<a href="#_ftn17">¹⁷</a></p><p> The dollar limit applies to partnerships and S corporations and to their partners and shareholders (to the extent the deduction is allowed (see IRC Section. 179(d)(8))). A partner or S corporation shareholder will reduce his or her basis in the partnership or S corporation to reflect the share of the cost of property for which an election to expense has been made whether or not such amount is subject to limitation at either the entity or partner/shareholder level.<a href="#_ftn18">¹⁸</a> Also, the partnership or S corporation will reduce its basis in the property by the amount of the deduction allocable to each partner or shareholder without regard to whether such individuals can use all of the deduction allocated to them.<a href="#_ftn19">¹⁹</a> Recapture provisions apply if the property ceases to be used predominantly in a trade or business before the end of the property's recovery period.<a href="#_ftn20">²⁰</a> Also, amounts expensed under such an election are treated as depreciation deductions for purpose of recapture on sale or disposition (see Q <a href="javascript:void(0)">7904</a>). </p><p><hr align="left" size="1" width="33%"></hr></p><p>1. IRC §§ 168(k)(2)(A)(ii), 168(k)(2)(E)(ii).</p><p>2. IRC § 168(k)(5).</p><p>3. IRC § 168(k)(5), as amended by ATRA § 331.</p><p>4. IRC § 168(k)(2).</p><p>5. IRC § 168(k)(6)(A).</p><p>6. IRC § 168(k)(8).</p><p>7. IRC § 168(k)(10).</p><p>8. IRC § 179, as amended by ATRA § 315, PATH § 143 and Pub. Law No. 115-97.</p><p>9. Treas. Reg. § 1.179-1(h)(1).</p><p>10. IRC § 179(b)(1).</p><p>11. IRC § 179(b)(2).</p><p>12. IRC § 179(b)(2), as amended by ATRA § 315, PATH § 143 and Pub. Law No. 115-97, Rev. Proc. 2020-45, Rev. Proc. 2021-45, Rev. Proc. 2022-38, Rev. Proc. 2023-34, Rev. Proc. 2024-40, Rev. Proc. 2025-32.</p><p>13. IRC § 179(b)(7), as amended by ESA 2008, ARRA 2009, HIREA and ATRA.</p><p>14. Rev. Proc. 2016-14, Rev. Proc. 2017-58.</p><p>15. IRC § 179(b)(7), as amended by ESA 2008, ARRA 2009, HIREA and ATRA.</p><p>16. IRC § 179(b)(3); Treas. Reg. § 1.179-3.</p><p>17. IRC § 179(b)(4).</p><p>18. Rev. Rul. 89-7, 1989-1 CB 178.</p><p>19. Treas. Reg. § 1.179-1(f)(2).</p><p>20. IRC § 179(d)(10); Treas. Reg. § 1.179-1(e).</p>

<div class="Section1"><br /> <br /> The normal recovery periods and methods may not be used for recovery property used predominantly outside the United States.<a href="#_ftn1" name="_ftnref1">¹</a> For property placed in service after 1986, a straight line method is used over the present class life of the property (12 years if no present class life)<a href="#_ftn2" name="_ftnref2">²</a> (see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="716">716</a>). For property placed in service before 1987, a declining balance switching to a straight line method was used over the present class life of the property (12 years if no present class life), unless an election was made for recovery property to use a straight line method over a different recovery period. The recovery period elected for pre-1987 property used predominantly outside the United States could not have been shorter than the present class life.<a href="#_ftn3" name="_ftnref3">³</a> Property is assigned to various class lives for purposes of depreciation in Revenue Procedure 87-56.<a href="#_ftn4" name="_ftnref4">⁴</a><br /> <br /> Property is considered used predominantly outside the United States if it is physically located outside the United States during more than 50 percent of the taxable year. If the property is placed in service after the start of the taxable year, the 50 percent determination is made for the period beginning when first placed in service and ending on the last day of the taxable year. This restriction applies whether the property is used predominantly outside the United States by the lessor or lessee. The determination is made with respect to the taxable year of the lessor.<a href="#_ftn5" name="_ftnref5">⁵</a><br /> <br /> There are certain listed exceptions to the restriction on use of normal recovery periods and methods for property used predominantly outside the United States.<a href="#_ftn6" name="_ftnref6">⁶</a> These include generally: aircraft, rolling stock, vessels, motor vehicles, and containers used partly in the United States for transportation or commerce; property used predominantly in certain possessions of the United States; certain U.S. communication satellites; submarine cable systems linking the United States and other countries; certain property used for exploring, developing, removing, or transporting resources from certain waters or land thereunder; and certain property used to generate energy for use in the United States. These may use normal periods and methods even if used outside the United States for more than 50 percent of the year.<br /> <br /> <div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>. IRC &sect; 168(g)(1)(A).<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>. IRC &sect; 168(g)(2).<br /> <br /> <a href="#_ftnref3" name="_ftn3">3</a>. IRC &sect; 168(f)(2), as in effect prior to amendment by TRA &rsquo;86.<br /> <br /> <a href="#_ftnref4" name="_ftn4">4</a>. 1987 CB 674 (Rev. Proc. 83-35, 1983-1 CB 745, for property placed in service before 1987).<br /> <br /> <a href="#_ftnref5" name="_ftn5">5</a>. Prop. Treas. Reg. &sect; 1.168(g)(5).<br /> <br /> <a href="#_ftnref6" name="_ftn6">6</a>. IRC &sect; 168(g)(4).<br /> <br /> </div></div><br />