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Taxes: Why Elect Out of the Depreciation Bonus?

Farm Business Management Update, December-January 2002/2003

By Daniel Osborne

As one might expect, the 2002 tax year has new legislation in effect to add to the ever increasingly complex tax law. This new legislation came primarily in the form of the Job Creation and Worker Assistant Act of 2002. The most significant piece of this legislation for the majority of Virginia farmers is the Depreciation Bonus. Businesses are allowed to take an additional 30% in depreciation for new property purchased after September 10, 2001 and before September 11, 2004. Of course, this is subject to several qualifications. The goal of the Depreciation Bonus is to encourage purchasing and thereby create jobs. (For more information on these qualifications, see the instructions to Form 4562.) If you have purchased new property that meets the qualifications for the Depreciation Bonus, you are required to take the additional 30% depreciation unless you elect out by attaching a statement to your return. Now, the question is why would you elect out of the Depreciation Bonus?

Several reasons come to mind where it may be beneficial to elect out of the depreciation Bonus. The first situation is if you are expecting higher income levels and, therefore, a higher tax rate in the next few years compared to the current year. Electing out will allow you to offset the higher income with more depreciation expense in the later years. If you plan to sell the purchased property in a year in which you are in a higher tax bracket, any depreciation recapture would be taxed at the higher rate. The problem of being in a higher tax bracket for up to two years later can be eliminated by using Schedule J to average income for three years, but this is more of a headache than just electing out of the Depreciation Bonus.

Another situation where electing out may be beneficial is when not electing out is going to cost more in record keeping than it is worth. If you buy $50,000 worth of equipment, you could expect to earn between $200 and $600 in interest from the Depreciation Bonus over the course of seven years by taking the extra depreciation now rather than later. Virginia is not going to allow the Depreciation Bonus in calculating the Virginia income tax. Therefore, if you do not elect out, you will have to calculate depreciation two different ways: one way for federal purposes and another for Virginia. The cost of paying a tax preparer to calculate depreciation two different ways for seven years could easily exceed $200.

Don't think that electing out of the Depreciation Bonus is what I am encouraging everyone to do. As I said, you could expect to earn between $200 and $600 in interest on the early tax savings. You should, however, consider your situation to determine whether electing out is to your advantage.

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