The IRS has provided a new safe harbor that corrects problems created by the interaction between the luxury automobile rules and the new 100 percent bonus depreciation deduction.
Tax law changes during 2010 increased and extended the bonus depreciation rules that permit you to write off more of the cost of a depreciable asset during the first year. In fact, 100 percent bonus depreciation can be claimed for most property placed in service September 8, 2010, and before January 1, 2012. One of the ambiguous areas likely to be of most concern to the small business owner was how the bonus depreciation rules interact with the luxury automobile rules. The IRS's recent Revenue Procedure provides some much needed clarity, albeit with a staggering amount of complexity.
Think ahead. This clarification does not affect the amount of depreciation that can be claimed for the first year that a luxury automobile is placed in service in your business. For 2010, the amount for passenger cars is $11,060 (for trucks and vans, the amount is $11,160.) However, this newly announced safe harbor will have an impact on your 2011 tax return.
Simply stated, due to the interaction of the luxury automobile limitations, the amount of "100 percent bonus depreciation" was limited to far less than 100 percent of the car's cost. In the case of a passenger car, the total first year depreciation on the 2010 tax return is limited to only $11,060. Moreover, because the bonus depreciation amount was (putatively) 100 percent, you were precluded from deducting the left-over basis (cost) until the limitation period expired. For an car purchased in 2010, you couldn't begin depreciating the amount disallowed by the limitation until 2016.
In order to provide a more equitable result for taxpayers, the IRS has created a "safe harbor." Under the safe harbor, you can claim a depreciation deduction for subsequent years that is the lesser of the amount annual limit available under the luxury auto tables or a "deemed amount" of depreciation that is determined under rules set out by the IRS.
To apply the safe harbor, it is first necessary to determine if there is unrecovered basis in car. Unrecovered basis is determined:
- without considering the luxury auto limitations and
- as if you had claimed the 50-percent additional first-year depreciation.
If you have unrecovered basis in your car—and you will if your car cost more than $18,450—you compare the "deemed depreciation amount" with the amount annual limit allowed by the luxury automobile rules and deduct the lesser. However, if your car cost less than $18,450, you do not have unrecovered basis. In this case, a different set of computations is required, although you will still only be permitted to deduct the lower of the deemed depreciation or the luxury auto limitation amounts.
The requirements and computations required under the safe harbor are complex. You should rely upon advice from a tax professional to ensure that the correct depreciation methods, tables and conventions are applied.