 Income tax 2022-2023, special depreciation allowance. Let's do some wealth preservation with some tax preparation. Most of this information comes from publication 946, How to Depreciate Property Tax Year 2022. You can find it on the IRS website, irs.gov, irs.gov. Looking at the income tax formula, we're focused on line one income. Remember, in the first half of the income tax formula is, in essence, an income statement. Although just an outline, the scaffolding, other forms and schedules flowing into these line items, one of those, the Schedule C, having business income minus business expenses, in essence an income statement in and of itself, the net business income flowing into line one income in our income tax formula. If we look at the form 1040, we note that the Schedule C would flow into the Schedule 1, flowing into the first page of the form 1040, line number eight. The Schedule C is the profit or loss from business form, structured as an income statement where we have income minus expenses. We are focused on the expenses side of things here, business deductions in essence, and more specifically on depreciation and more specifically still on a special type of depreciation. Remember, the general outline is expenses that are ordinary and necessary in order to generate revenue are expenses we can typically take when we have a deviation, a big deviation with the purchase of property planting equipment from a cash-based type of system, meaning support accounting instruction by clicking the link below, giving you a free month membership to all of the content on our website broken out by category, further broken out by course, each course then organized in a logical, reasonable fashion, making it much more easy to find what you need than can be done on a YouTube page. We also include added resources such as Excel practice problems, PDF files, and more like QuickBooks backup files when applicable. So once again, click the link below for a free month membership to our website and all the content on it. Even if we have a cash-based type of system, when we buy property planting equipment, the code is going to force us to do an accrual thing, putting it on the books as an asset and depreciating it over its useful life, which is a normal kind of accounting concept, but then they might add accelerated depreciations, which are still kind of normal accounting concepts, but then special front-loaded depreciations and 179 type of deductions, which are more designed to like stimulate the economy and have rationale that is usually different than normal accounting rationale. And that's what we're talking about here. Remembering that from a tax standpoint, normally we would like to get the deduction as soon as possible. We want the deduction to be as high as possible and get it as soon as possible because of the time value of money, although there are exceptions to that rule. Okay, given that, we want to talk about claiming the special depreciation allowance introduction. So you can take a special depreciation allowance to recover part of the cost of qualifying property defined next placed in service during the tax year. The allowance applies only for the first year you place the property in service. So this is the point. It's like a big upfront type of deduction that you might be able to get for types of property that you would otherwise have to depreciate over the useful life of the property. The allowance is an additional deduction you can take after any section 179 deduction and before you figure regular depreciation under the makers. That's the normal kind of depreciation method, basically like a double declining method. So we're trying to take this before we kick into the normal depreciation which would allocate over multiple years in the future. The 179 as we have talked about in the past is another kind of format of special depreciation kind of upfront depreciation. So for some time at this point in time, they've been trying to stimulate the economy most likely overheating the economy trying to push too hard possibly at this point and that's why they've got these big front loaded items in the tax code. Now it looks like just from an economic standpoint that we might be overheating the economy right now which you would think that would lead them to kind of try to pull back on some of these kind of stimulating things but that's unpopular to do. So it will be interesting to see in the future what they do with like the 179 deduction and the special depreciation deductions. In any case, you figure regular depreciation of makers for the year you place the property in service. Okay, this chapter explains what is qualified property. It also includes rules regarding how to figure an allowance, how to elect not to claim an allowance and when you must recapture an allowance. Okay, what is qualified property? So your property is qualified property if it is one of the following. Qualified reuse and recycling property. Certain qualified property acquired after September 27, 2017 and certain plants bearing fruits and nuts. The following discussion provides information about the types of qualified property listed above for which you can take the special depreciation allowance. Qualified reuse and recycling property. You can take a 50% special depreciation allowance for qualified reuse and recycling property. Qualified reuse and recycling property is any machinery or equipment not including building or real estate along with any apportionments that used exclusively to collect, distribute or recycle qualified reuse and recyclable materials as defined in section 168M3B of the internal revenue code. Qualified reused and recycling property also includes software necessary to operate such equipment. The property must meet the following requirements. The property must be depreciated under makers. That's the general kind of depreciation rules. The property must have a useful life of at least five years. So it's not under five years in terms of the length of the life. The original use of the property must begin with you after August 31, 2008. You must have acquired the property by purchase as discussed under property acquired by purchase in chapter 2. After August 31, 2008 with no binding written contract for the acquisition in effect before September 1, 2008 the property must be placed in service for use in your trade or business after August 31, 2008. So accepted property. Qualified reuse and recycling property does not include any of the following. Any rolling stock or other equipment used to transport reuse or recyclable materials property required to be depreciated using the alternative depreciation system that's the ADS not the makers which is the standard form at this point in time. For other property acquired to be depreciated using ADS as required use an ADS under which depreciation system GDS or ADS applies in chapter 4. We'll talk more about that possibly later. Other bonus depreciation property to which section 168K of the internal revenue code applies property for which you elected not to claim any special depreciation allowance. We'll discuss that later. Property placed in service and disposed of in the same tax year. Property converted from business use to personal use in the same tax year acquired. Okay, certain qualified property acquired after September 27, 2017. So you can elect to take 100% special depreciation allowance for property acquired after September 27, 2017 and placed in service before January 1, 2023 or before January 1, 2024 for certain property with a long production period and for certain aircraft. So your property is qualified property if it meets the following. So we've got tangible property depreciated under makers tangible meaning you can touch it makers being the normal kind of depreciation type of rules with a recovery period of 20 years or less. 20 years or less when you get over the 20 years you're often you know going to start getting into like real estate property which has those longer lives over that point. So computer software defined in and depreciated under section 167F1 of the internal revenue code. Water utility property, qualified film, television and live theatrical productions as defined in sections 181D and E of the internal revenue code. A specified plant for which you made the election to apply section 168K5 for the tax year in which the plant is planted or grafted explained later under certain plants bearing fruits and nuts. So it is not except accepted property explained later under accepted property. Okay so qualified property must also be placed in service before January 1, 2027 or before January 1, 2028 for certain property with a long production period and for certain aircraft and can be either new property or certain used property. Note for certain qualified property acquired after September 27, 2017 and placed in service after December 31, 2022 and before January 1, 2024 other than certain property with a long production period and certain aircraft you can elect to take an 80% special depreciation allowance. Alright so now we're looking at the long production period property. To be qualified property, long production period property must meet the following requirements. The property has a recovery period of at least 10 years or is transportation. Transportation, chaos. Property. Transportation property is tangible. You can touch it, personal property used in the trade or business of transporting persons or property. The property is subject to section 263A of the Internal Revenue Code. The property has an estimated production period exceeding one year and an estimated production cost exceeding $1 million. You must have acquired the property or acquired the property pursuant to a written contract entered into before January 1, 2027. Okay so now we've got the non-commercial aircraft. I'm going to go through these fairly fast because some of these are kind of special type of areas that you might not have like non-commercial aircraft is going to be specific to specific areas. So to be qualified property, non-commercial aircraft must meet the following requirements. The aircraft must not be tangible personal property used in the trade or business of transporting persons or property except for agricultural or firefighting purposes. The aircraft must be purchased as discussed under property acquired by purchase in Chapter 2 by a purchaser who at the time of the contract for purchase makes a non-refundable deposit of the lesser of 10% of the cost or $100,000. The aircraft must have an estimated production period exceeding four months and a cost exceeding $200,000. You must have acquired the aircraft or acquired the aircraft pursuant to a written contract entered into before January 1, 2027. Special rules syndicated leasing transactions. Again I'm going to go through this fairly quickly because this is a special type of situation. If qualified property is originally placed in service by a lessor, the property is sold within three months of the date it was placed in service and the user of the property does not change, then the property is treated as originally placed in service by the taxpayer no earlier than the date of the last sale. Multiple units of property subject to the same lease will be treated as originally placed in service no earlier than the date of the last sale if the property is sold within three months after the final unit is placed in service and the period between the time the first and last units are placed in service does not exceed 12 months. Okay, accepted property. Qualified property acquired after September 27, 2017 does not include any of the following. So these are going to be the specific exceptions to the rule. So property placed in service or planted or grafted and disposed of in the same tax year. So if you did it in the same tax year, you would think it wouldn't be a long term property wouldn't be normally a depreciable type of item. So that would be exempted property converted from business use to personal use in the same tax year acquired. You have a similar situation here. It's not really long term property. If it was business property, but then you converted it to personal use because you would only get the deduction you would think if it was business related, not personal related property converted from personal use to business use in the same or later tax year may be qualified property. Property required to be depreciated under the alternative depreciation system because that's the ADS system. We'll talk about the ADS versus the maker system in future presentations. But currently you would think that most of the depreciable property would be under the makers system, not the ADS of the ADS would be an indication that it might not qualify then for this either. So this includes listed property used 50% less in a qualified business use for other properties required to be depreciated using ADS. You can see required use of ADS under which depreciation system ADS or I'm sorry, GDS or ADS applies in Chapter 4 property for which you elected not to claim any special depreciation allowance. So you could just elect out of the special depreciation. Why would you do that? Possibly because you don't want to take the depreciation in the current year because maybe the current year doesn't have as much income as you think later years will have. And you would rather get the deduction in later years breaking from the normal rule of I would like to get the deduction as high and as soon as possible due to the time value of money. Property described in Section 168K9A and placed in service in any tax year beginning after December 31, 2017. Property described in Section 168K9B and placed in service in any tax year beginning after December 31, 2017. Certain plants bearing fruits and nuts. You can elect to claim a 100% special depreciation allowance for the adjusted basis of certain special plants defined later bearing fruits and nuts planted or grafted after September 27, 2017. And before January 1, 2023, a specified plant is any tree or vine that bears fruits or nuts and any other plant that will have more than one yield of fruits or nuts and generally has a pre productive period of more than two years from planting or grafting to the time it begins bearing fruits or nuts. So any property planted or grafted outside the United States does not qualify as a special as a specified plant. If you elect to claim the special depreciation allowance for any specified plant, the special depreciation allowance applies only for the tax year in which the plant is planted or grafted. The plants will not be treated as qualified property eligible for the special depreciation allowance and the subsequent tax year in which it is planted in service. So to make the election, attach a statement to your timely filed return, including extensions for the tax year in which you plant or graft the specified plants, indicating you are electing to apply section 168K5 and identifying the specified plants for which you are making the election the election once made cannot be revoked without IRS consent. So again, that to me is more of a specialty type of situation. I haven't dealt with taxpayers as much with that situation with the planting, but it might be applicable to a lot of people. In any case, note for certain specified plants bearing fruits and nuts planted or grafted after December 31, 2022 and before January 1, 2024, you can elect to claim an 80% special depreciation allowance. See section 168K5 of the Internal Revenue Code for more detail. How much can you deduct? Let's get down to the nitty and the gritty. Figure the special depreciation allowance by multiplying the depreciable basis of qualified reuse and recyclable property, certain qualified property acquired after September 2017 and certain plant bearing fruits and nuts by the applicable percentage. For qualified property other than listed property, enter the special depreciation allowance on form 4562 that we've seen in prior presentations, Part 2, Line 14. For qualified property that is listed property, enter the special depreciation allowance on form 4562 Part 5, Line 25. Tip, if you place qualified property in service in a short tax year, you can take the full amount of a special depreciation allowance. Depreciable basis, this is, so now we're talking about the depreciable basis kind of like the adjusted cost, right? This is the property's cost or other basis multiplied by the percentage of business investment use. So the cost of whatever you're putting in place, you're not expensing it, you're putting it on the books as an asset to be depreciated, but now you want to apply the special depreciation. If you had a partial personal use versus business use, you would think you would have to then multiply it by the percent of business use to adjust the basis to whatever is business. In other words, if it was 80% business use, you would think you have to multiply it times 80% to get the basis. So basis investment use reduced by the total amount of any credits and deductions allocable to the property. The following are examples of some credits and deductions that reduce depreciable basis. So you got this, you got any section 179 deduction. So if you took a 179 deduction, which is another kind of upfront type of deduction, that's going to be an adjustment to the basis that then might be applicable. Then if you're also doing the special. So any deduction for removal removal or barriers to the disabled and the elderly. Any disabled access credit enhanced oil recovery credit or credit for employer provided childcare facilities and services basis adjustment to investment credit property under section 50 C of the internal revenue code section 181 expense deduction. For additional credits and deductions that affect basis C sections 1016 of the internal revenue code for information about how to elect the cost or other basis of property. See what is the basis of your depreciable property in chapter one for a discussion of business. There's another link that you can take a look at here, but in any case that is that depreciating the remaining cost. So after you take, you know, the special depreciation upfront, then you may have basis left over then that you might need to be depreciating in a normal kind of basis then going forward. So after you figure your special depreciation allowance for your qualified property, you can use the remaining cost to figure your regular makers. That's going to be the normal depreciation methods. Oftentimes we'll talk about later depreciation deduction discussed in chapter four. So therefore you must reduce the depreciable basis of the property by the special depreciation allowance before figuring your regular makers depreciation deduction. So so which would make sense. So right. So because you got this depreciable property, you put it on the books as an asset, you're going to depreciate it over the useful life. But instead of using straight line depreciation, you use makers, which is usually a form of double declining balance. But then you might have these upfront kind of deductions. You get upfront like the special depreciation or the 179 depreciation, which might completely allow you to take the full amount upfront of the cost. Just like if you would have just been allowed to expense it without doing this whole capitalization thing in the first place. But if you don't get the full amount upfront, then you would take the remaining basis that you didn't get to write off upfront and allocate it according to the normal depreciation rules of makers usually. So once again, therefore you must reduce the depreciate the depreciable basis of the property by the special depreciation allowance before figuring your regular makers depreciation deduction example. On July 1st, 2022, you place in service in your business qualified property that costs $450,000 and that you acquired after September 27, 2017, you did not elect to claim a section 179 deduction. So we're not going to mess muddy up the waters with the 179. So you deduct 100% of the cost $450,000 as special depreciation allowance for 2022. You have no remaining cost to figure a regular makers depreciation deduction for your property for 2022 and later years. So that's a typical case in these cases for small businesses and that the special depreciation completely wiped out the whole amount just like you would have been able to just expense it in the first place without having to go through this business of putting it on the books as an asset in the first place. Like kind exchanges and inventory conversion. So if you acquire qualified property in a like kind exchange or involuntary conversion. So like kind of exchange you're often dealing with real estate with it, which is a life kind kind of exchange involuntary conversion possibly. So you're out here will pay you some money for that right. So or involuntary conversion after September 27, 2017 and the qualified property is new property that carry over basis and any excess basis of the acquired property is eligible for the special depreciation allowance. If you acquired qualified property in a like kind exchange or involuntary conversion after September 27, 2017 and the qualified property is used is used property. Only the excess basis of the acquired property is eligible for the special depreciation allowance after you figure your special depreciation allowance. You can use the remaining carry over basis to figure your regular makers depreciation deduction. So somewhat of a more unusual situation, although they do come up fairly often. You can see figuring the deduction for property acquired in non taxable exchange in chapter four under how to depreciate deduction figured. So how can you elect not to claim an allowance? So you might say, what if I don't want to claim the allowance? So you can elect for any class of property, not to deduct any special depreciation allowance for all property in such class placed in service during the tax year. So why would you want to do that? Because again, you might have a situation where your taxes are lower this year possibly because you have left income putting you into a lower tax bracket than you think might happen in following years. So you'd rather not take the big deduction this year and possibly spread it out over the future years where maybe you have higher tax brackets you are expecting to make an election. Attach a statement to your return indicating what election you are making and the class of property for which you are making the election tax software helps with this process. The election must be made separately by each person owning qualified property. For example, by the partnership by the S corporation or for each member of a consolidated group by the common parent of the group. So when to make the election? Generally, you make the election on a timely file tax return, including extensions for the year in which you place the property in service. However, that would make sense, of course. However, if you timely filed your return for the year without making the election, you can still make the election by filing an amended return within six months of the due date of the original return, not including extensions. Attach the election statement to the amended return on the amended return right filed pursuant to section 301.9100-2. Revoking an election. So now you want to change it. Once you elect not to deduct a special depreciation allowance for a class of property, you cannot revoke the election without IRS consent. So you want to make sure that you're sure about what you're doing in that case and not trying to flip flop on it. A request to revoke the election is a request for a letter ruling caution. If you elect not to have any special depreciation allowance applied, the property placed in service after 2015 will not be subject to an alternative minimum tax adjustment for depreciation. When must you recapture an allowance? We have this recapture type of situation because when we allow this big depreciation upfront, it can cause issues when we sell the property, especially if we have a situation where we have different tax rates for different types of income. For example, capital gain income and ordinary income. So when you dispose of property for which you claimed a special depreciation allowance and a gain on the disposition is generally recaptured included in income as ordinary income up to the amount of the special depreciation allowance previously allowed or allowable. See when do you recapture maker's depreciation in chapter four for more information. So the general idea here would be if you sold the property and you are going to end up with a gain. Part of the question is, well, is that a capital gain or is that going to be an ordinary income gain? Sometimes when you sell property that is a long lasting type of property, it might be subject to a capital gain in some cases, which most commonly for individual taxpayers would be applied to like the sale of stock, for example, which you might have a favorable tax rate for. And usually the rationale for the rate for the favorable tax rate would be that if you had a long term investment type of thing, the gain might have accumulated over a long period of time. And if you sold it all in one year, then that big gain that you get in that one year could increase your tax brackets because it's going to result in you realising that giant gain that actually happened over multiple years in one year. And because we have a progressive tax system, it could increase your ordinary income rates. So that's one argument to have like different rates related to capital gains versus ordinary income, the capital gains rates being a favourable rate. But in this situation, the gain that's going to be generated is probably and almost certainly kind of artificial because when you take a look at the basis of the property that you sold, it's artificially low because the IRS has been putting in place these special depreciation, which allowed you to get this big expense upfront instead of doing what would normally be done under normal accounting rules, which would be to allocate the cost over the useful life of the property. So when you do that, you can imagine a situation where people try to take advantage of that situation where they would basically possibly buy property. They get this massive depreciation of the property in ordinary income deductions and then they try to sell it in the future year where they end up with this giant gain. But the gain would be taxed not at ordinary income rates, but rather at capital gain rates, favourable rates. So you can imagine the tax code would have to have a recapture, then you'd have to say, no, you can't do that. If you had a gain that was only due to over depreciation in the past or because of the special depreciation, then you have to recognize the income as ordinary income. Why? Because you got a deduction that was on the basis of ordinary income. So when you have these differences in the tax rates, it causes these kind of issues.