Safe Harbor Coordinates 100% Bonus Depreciation and Luxury Car Depreciation Caps

A new IRS safe harbor coordinates 100% bonus depreciation with the annual depreciation caps for luxury cars. The long-expected safe harbor lets vehicle owners deduct depreciation in each year of the recovery period even if they also claim bonus depreciation.

Bonus Depreciation and Luxury Car Caps

Bonus depreciation allows a taxpayer to deduct 100% of the cost of qualified property in the year it is placed in service. Most vehicles used for business purposes are qualified property.

However, the “luxury car” caps impose annual limits on depreciation deductions for most cars and trucks. “Luxury car” is a bit of a misnomer, since the caps apply to almost all vehicles that weigh less than 6,000 pounds.

For a vehicles placed in service during 2018, the luxury car caps limit depreciation deductions to:

  • $18,000 for the first year,
  • $16,000 for the second year,
  • $9,600 for the third year, and
  • $5,760 per year beginning with the fourth year.

These caps are maximums. The taxpayer simply deducts normal depreciation if that amount is less than the annual cap.

How the Vehicle Depreciation Safe Harbor Works

Without safe harbor relief, depreciation that exceeds the first-year cap can be deducted only at the end of the vehicle’s five-year recovery period. This is because regular depreciation ignores the depreciation caps. Thus, a taxpayer who claims 100% bonus depreciation has to treat the vehicle as fully depreciated for the rest of its recovery period– even though the cap limited the actual depreciation deduction to $18,000.

Under the safe harbor, depreciation deductions after the first year are limited to the lesser of:

  • the applicable luxury car cap,
  • or depreciation computed using table percentages on the cost of the vehicle.

Vehicle Depreciation Safe Harbor Example

Imagine that Carl Carowner  buys a car in 2018 for $60,000 and begins using it 100% for his business. The car is MACRS five-year property subject to the half-year convention. It is not exempt from the luxury car caps because its gross vehicle weight rating is 6,000 pounds or less.

Without the safe harbor, Carl can claim a depreciation deduction of $18,000 for 2018. However, for the rest of the car’s recovery period, he is treated as having claimed the maximum possible depreciation deduction. Thanks to 100% bonus depreciation, this is the full cost of the car. Thus, he has to wait until the end of the recovery period to start depreciating his remaining $42,000 basis. What’s more, these depreciation deductions are still subject to the $5,760 annual cap.

Effect of the Vehicle Depreciation Safe Harbor

Under the safe harbor, however, Carl can continue to claim depreciation deductions during the car’s recovery period. Thus:

  • In 2018, Carl deducts $18,000 (the maximum allowed by the luxury car cap).
  • In 2019, he deducts $13,440 ($42,000 × 32% second year table percentage) because this is less than the $16,000 second-year cap.
  • In 2020, he deducts $8,064 ($42,000 × 19.20% third-year table percentage) because this is less than the $9,600 third-year cap.
  • In 2021 and 2022, he deducts $4,838 ($42,000 × 11.52% fourth and fifth-year table percentage) because this is less than the $5,760 fourth and fifth-year cap.
  • In 2023, the last year of the car’s recovery period, Carl deducts $2,419 ($42,000 × 5.76% sixth-year table percent) because this is less than the $5,760 sixth-year cap.

At the end of 2023, Carl has deducted a total of $51,599 in depreciation, leaving him with $8,401 in  unrecovered basis ($60,000 – $51,599). He can recover this amount beginning in 2024, but the $5,760 annual depreciation cap still applies. Thus, he deducts $5,760 in 2024, and $2,641 in 2025.

How to Elect the Vehicle Depreciation Safe Harbor

A taxpayer elects the safe harbor simply by using it in the second year of the vehicle’s recovery period. At first glance this may seem odd. However, remember that the safe harbor does not affect depreciation calculations until the second year of the recovery period. With or without the safe harbor, a taxpayer’s bonus depreciation deduction for a vehicle in 2018 is limited to $18,000.

Additional Safe Harbor Rules

The safe harbor has several limits and conditions:

  1. The safe harbor applies only to taxpayers that claim 100% bonus depreciation.
  2. The safe harbor does not apply if a taxpayer expenses any portion of the vehicle under IRC §179.
  3. A taxpayer electing the safe harbor must also use the depreciation table percentages.
  4. As usual, the taxpayer must reduce depreciation deductions to reflect personal use of the vehicle, as well as short tax years.

Special Safe Harbor Issues for Vehicles from Late 2017

Some special rules may apply if a calendar-year taxpayer  acquired and placed a vehicle in service after September 27, 2017, and before January 1, 2018.

First, the taxpayer must elect the safe harbor on its 2018 return, because 2018 is the second year in the vehicle’s recovery period. Of course, the taxpayer must also use the depreciation caps for vehicles placed in service in 2017, which are lower than the 2018 caps.

However, some of these taxpayers may be ineligible for the safe harbor because their 2017 returns:

  • elected out bonus depreciation, or
  • claimed a §179 deduction on the vehicle.

Taxpayers that claimed the §179 deduction on their 2017 returns can revoke the election on an amended return filed within the three year limitations period.

However, a taxpayer that elected out of bonus depreciation (or elected 50% bonus depreciation for a tax year that included September 28, 2017) may revoke the election only on an amended return filed within six months of the original due date of the return (excluding extensions). If this deadline has passed, the taxpayer must file a letter ruling with the IRS to get permission to revoke the election.

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CCHTaxGroup

All stories by: CCHTaxGroup