Section 179 and Bonus Depreciation
By Jason Watson, CPA
Posted Tuesday, October 12, 2021
Let’s talk about the Hummer Loophole since that is where most taxpayer confusion comes from. Yes, at some point, long ago, in a galaxy far far away, businesses could buy heavy trucks and deduct them 100%. Was this a loophole of sorts? Yes. Does Congress and the IRS like loopholes? Not really, unless it benefits them. Did Congress change the Hummer Loophole? Yes. What is the current state of affairs after the Tax Cuts and Jobs Act of 2017 (TCJA)? Good question, read on (sneak peek, we are back to 100% for heavy trucks… Hummers for everyone Oprah!).
Switching gears to which business automobiles are eligible for 100% Section 179 deduction under the current tax laws after the TCJA. The following trucks and business automobiles qualify for 100% deduction in Year 1-
- Automobiles that can seat nine-plus passengers behind the driver’s seat (i.e.: Hotel / Airport shuttle vans, etc.).
- Automobiles with: (1) a fully-enclosed driver’s compartment / cargo area, (2) no seating at all behind the driver’s seat, and (3) no body section protruding more than 30 inches ahead of the leading edge of the windshield. In other words, a classic cargo van.
- Heavy construction equipment will qualify for the Section 179 deduction, as will forklifts and similar.
- Typical “over-the-road” Tractor Trailers will qualify.
This is straight from the Section179.org website who does a fantastic job of explaining this stuff. So what are the Section 179 deduction limits for passenger automobiles and heavy trucks that don’t meet the list above? That is another really good question!
The following is directly from the IRS website speaking in reference to the TCJA-
The new law changed depreciation limits for passenger vehicles placed in service after Dec. 31, 2017. If the taxpayer doesn’t claim bonus depreciation, the greatest allowable depreciation deduction is:
$10,000 for the first year,
$16,000 for the second year,
$9,600 for the third year, and
$5,760 for each later taxable year in the recovery period.
If a taxpayer claims 100 percent bonus depreciation, the greatest allowable depreciation deduction is:
$18,000 for the first year,
$16,000 for the second year,
$9,600 for the third year, and
$5,760 for each later taxable year in the recovery period.
The new law also removes computer or peripheral equipment from the definition of listed property. This change applies to property placed in service after Dec. 31, 2017.
Where do some of these limits come from? The $10,000 for the first year comes from the Section 280F limitation. The $18,000 for the first year comes from the Section 280F limitation plus applying Section 168(k) bonus depreciation. There was a hiccup in the tax code that disallowed depreciation in subsequent years if accelerated depreciation was taken. But just like in 2011, the IRS released IRS Revenue Procedure 2018-25 which provided safe harbor for depreciation in subsequent years.
Again, these numbers are based on luxury passenger vehicles; in other words, vehicles that weigh 6,000 pounds or less. Why is this important… keep going!
You say, “so, my heavy SUV doesn’t qualify for a 100% deprecation deduction under Section 179 because of the seating and configuration of the cargo hold, so now what?” Another really good question! Keep ‘em coming! We have the answers.
The order of depreciation is Section 179 Deduction, then Bonus Depreciation and then regular depreciation. This means you apply limits, subtract the allowance and then apply subsequent laws to the remaining amounts. A truck or SUV that weighs more than 6,000 pounds is not considered a luxury automobile and therefore is not limited by Section 280F in the same way.
As such, the first year depreciation deduction for your heavy business automobile would be-
- $25,000 under Section 179 (actually it is $26,200 for the 2021 tax year according IRS Revenue Procedure 2020-45 which makes inflation adjustments), plus
- 100% Bonus Depreciation under Section 168(k)
So that $90,000 Ford F-250 truck that comes in around 6,700 pounds would be fully deductible in Year 1. Wow! That is good news, right? Right! The Hummer Rule is back baby! Do I have to buy a new heavy truck to qualify for the bonus depreciation? No. The old rule was Yes, but the TCJA changed that too. Here is the blurb from the IRS website–
- The taxpayer didn’t use the property at any time before acquiring it (read, new to you not “brand” new or never been used, emphasis emphatically added).
- The taxpayer didn’t acquire the property from a related party.
- The taxpayer didn’t acquire the property from a component member of a controlled group of corporations.
- The taxpayer’s basis of the used property is not figured in whole or in part by reference to the adjusted basis of the property in the hands of the seller or transferor.
- The taxpayer’s basis of the used property is not figured under the provision for deciding basis of property acquired from a decedent.
So there you go. The problem still remains with luxury passenger automobiles weighing under 6,000. Those limits are $18,000 for the first year under Section 280F and there are problems in subsequent years that we don’t want to bore you with, but if you want to read IRS Rev. Proc. 2011-21 for nauseating examples, then go for it.
The bottom line is this- to maximize your Section 179 deduction for the business automobile purchase, buy an automobile that weighs over 6,000 pounds. Or… instead of driving Miss Daisy, drive a sumo wrestler to push you over 6,000 pounds (kidding!).
Leasing or Financing
If your business leases the automobile, the business portion of the lease amount is expensed. However, there are limits to how much can be expensed, especially for expensive or what the IRS would consider luxury automobiles. The disallowed lease payment is called a lease inclusion and is detailed in IRS Revenue Procedure 2016-23. The amount is added back into income and taxed, leaving only the IRS allowed portion as a deductible lease expense. So before you lease that brand new 911, call us. We’ll determine a plan after the joint test-drive.
Also consider that leases are generally bad, especially on business automobiles over $80,000 for three really big reasons. First, the residual value offered on a 36-month lease will be about 60% or $48,000. This is essentially what the leasing business believes the automobile will be worth after 3 years. Yuck #1.
Second, they take the degradation in value ($80,000 minus $48,000) and apply a capitalization rate of 8% to 12%. This is essentially your interest rate. Yuck #2.
Third, they put ridiculous mileage limitations such as 10,000 miles per year with heavy penalties for going over the limit. 10,000 miles is laughable for most modern-day business owners or families. Yuck #3.
Sure, if you lease a more economical automobile such as a Subaru Crosstrek for $30,000 then Yuck #1 goes away. But Yucks #2 and #3 remain. Also, automobile leases are generally not capitalized leases (they do not have a bargain purchase option) and therefore they cannot take advantage of the Section 179 deduction or Bonus Depreciation. Contrast that with your leased copier with a $1 buy-out option… this is considered “financing” or a capitalized lease, and the asset can be listed on your balance sheet, depreciated, painted purple, etc.
Another consideration- if you are driving the business car and get into an accident, the business might get into a liability rodeo just based on ownership. Proving that at the moment you were driving the car for personal reasons might not matter. We are not attorneys, but this scenario is not beyond possibility.
Lastly, and this is yet another big deal, any personal use must be considered taxable income as an employee of your S corporation. Don’t laugh, it’s true! How do you calculate the amount of imputed income? The easiest and most widely accepted way is to use the Annual Lease Value Table in IRS Publication 15-B Employer’s Tax Guide to Fringe Benefits.
For the 2021 tax year, the lease value of a $50,000 automobile is $13,250 annually. If you use the business-owned automobile for personal use 10% of the time, then $1,325 will be added to your W-2 and taxed as compensation (including Social Security and Medicare taxes, and all the taxes you would expect). Here is the link to IRS Publication 15-B-
You can also use the mileage rate, but there are strong limitations such as the fair market value of the automobile must be below $51,500 (for the 2021 tax year). That will preclude some automobiles. But let’s run the math anyways.
For example, you drove 15,000 miles and 5,000 miles were personal. You would need to add 5,000 miles x 56 cents (for the 2021 tax year) which equals $2,800 to W-2 income. And here’s the personal use kicker- if you are operating your car for less than the standard mileage rate (and you usually do), you will artificially be inflating your income.
Having a mixed use (personal and business) automobile be owned by the business sounds like a lot of work. Everyone at our office likes French fries, but we won’t run a mile for just one. Let’s make sure it’s worth it. Will the tax benefit of depreciation in the first two years offset the additional imputed income? Perhaps.
Keep in mind that it is difficult to justify 100% business use of an automobile if it is the only automobile you own- perhaps in Manhattan, but not for most Americans. Even if you have another automobile at your disposal, it still might not make sense to have your business own it. The question boils down to how many miles you will drive versus your ability to accelerate your depreciation versus your marginal tax rate today and the following years. At the end of this section on automobiles is an overly simplified flowchart to help you decide (or confuse the situation more).
LLC Owned But Using Standard Mileage Rate
If you are operating an LLC without the S corporation election, you might be tempted to use the standard mileage rate. Typically this would be ill-advised- if you are using the standard mileage rate you are probably better off owning the automobile personally and be reimbursed by the LLC. However, there are situations where this might make sense.
Let’s look at the myriad of rules where using the standard mileage rate method is not allowed.
According to IRS Publication 463, you cannot use the standard mileage rate when you-
- Use five or more cars at the same time (such as in fleet operations), or
- Claimed a depreciation deduction for the car using any method other than straight line (such as MACRS), or
- Claimed a section 179 deduction on the car, or
- Claimed the special (bonus) depreciation allowance on the car, or
- Claimed actual car expenses for a car you leased, or
- Did not use the standard mileage deduction during the first year of use.
This makes sense. The IRS does not want you to exploit the system by claiming huge amounts of depreciation in the first year, and then switch to the possibly more lucrative standard mileage rate deduction. Here is the link for the IRS Publication 463 (Travel, Entertainment, Gift, and Car Expenses)-
Again, if your LLC owns the automobile but is using the standard mileage rate and your LLC elects S corporation status for taxation, this asset needs an adjusted cost basis for depreciation within the corporation. Why? As an S Corp where the business owns the automobile, the business can only use actual expenses and depreciation is a part of that.
The calculation for determining the basis of the automobile is quite simple since the IRS publishes the depreciation amount within the standard mileage rate. Here’s the math from IRS Notice 2019-02–
|Purchase Price, 2017||50,000|
|2017 Depreciation @ $0.24 per Mile for 10,000 Miles||2,400|
|2018 Depreciation @ $0.25 per Mile for 10,000 Miles||2,500|
|2019 Depreciation @ $0.26 per Mile for 10,000 Miles||2,600|
|Adjusted Cost Basis on 12/31/2019||42,500|
In this example, if the LLC elects S corporation status on January 1 2019, an asset would be created on the S corporation’s balance sheet with an adjusted basis of $42,500. The depreciation schedule for an automobile is typically five years, but when you switch from standard mileage rate to actual expenses (e.g., LLC electing S Corp status) the IRS requires you to estimate the remaining useful life. This is another conundrum. In this example, somewhere between two years and five years would be reasonable.
We just went over a ton of stuff under the Business Owns the Automobile section. Please look at a quickie decision tree later in this chapter.
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