According to a summary prepared by Finance Committee staff, the draft proposes a modern, simpler, and fairer cost recovery and tax accounting system—one that would aim to promote tax neutrality when it comes to business decisions.
The following description provides a high-level, general summary of the depreciation provisions and other proposals in the draft. There are numerous special rules that are not addressed in this discussion.
The discussion draft would repeal the current rules for depreciation of tangible property—MACRS—and replace them with a new pooled asset cost recovery system and separate rules for depreciation of buildings and certain other real property.
The new system would be effective for tax years beginning after December 31, 2014. Assets already being depreciated at that time would henceforth be depreciated under the new system.
Most tangible property would be assigned to one of four open-ended pools, which are generally defined by specific asset classes.
- The aggregate balance in each pool at the end of a tax year would be depreciated by applying a statutory rate to it.
- The balance would consist of the original basis of the assets in the pool, increased by capitalized improvements to assets in the pool during the year, and reduced by the depreciation on the pool for preceding tax years.
- The full basis of a new asset would be added to the pool in the year it is placed in service.
- The draft proposal would allow a taxpayer to elect, asset by asset, to determine the placed-in-service year consistently with its method for financial statement tax depreciation.
- If an asset is disposed of during the year, the pool would not be reduced by the basis of that asset. Rather, the pool would be reduced by the gross proceeds from any disposition or transfer of a pool asset. If a pool had a negative balance at the end of the year, an amount would be added back to the pool and treated as ordinary income. If no assets remained in the pool, the balance would be deducted as an ordinary deduction. However, so long as there are assets in a pool, the same declining balance depreciation method would continue to be applied each year to determine the annual depreciation deduction.
The pools and their depreciation rates were determined by the Congressional Budget Office (CBO) and the staff of the Joint Committee on Taxation, with the intent of aggregating asset classes based on their estimated economic rates of decline.
- Pool 1 contains computers, computer software, automobiles that are used exclusively in a trade or business, and several other items. It has a depreciation rate of 38%--that is, a deduction equal to 38% of the balance in the pool would be allowed each year, so long as there were any assets left.
- Pool 2 has a depreciation rate of 18%.
- Pool 3 has a depreciation rate of 12%. There is no exact correlation to the current MACRS recovery classes.
- Pool 4 includes mainly assets that have a 10-year or longer recovery period under current law, and has a depreciation percentage of 5%.
In almost every situation, the first-year depreciation would be less than under current law, and the depreciation would be less accelerated over the years.
Buildings and certain other assets that tend to have long recovery periods under current law (such as utility plants) would statutorily be characterized as “real property” and depreciated, as discrete assets, over 43 years using the straight-line method.
Treasury and the IRS would be authorized to reclassify property between asset classes or between pools, or between real property and the pools, and also to redefine the asset classes.
Assets that are used in a trade or business but for less than 50% of the time would not be depreciable. Assets used greater than 50% but less than 100% would only be proportionately depreciable. Automobiles with any personal use would be depreciated over a five-year period using the straight-line method. Generally, no more than $45,000 of depreciation would be allowed on a personal use automobile over its life.
The proposal would eliminate bonus depreciation and numerous special depreciation schedules, or first-year benefits, for particular types of property. There would be no alternative system that applies to property used outside the United States or by tax-exempt entities. There would no longer be a depreciation adjustment in computing alternative minimum tax.
Property already being depreciated would be assigned to the appropriate pool at the beginning of the 2015 tax year, at its adjusted basis, and depreciated under the pool system going forward. The 43-year recovery period for real property already being depreciated would be reduced by the number of tax years the property had already been depreciated before 2015.
Expanded section 179 expensing, R&E expenses, advertising expenses
The limit on section 179 expensing would be raised to $1 million in the first tax year beginning after 2014, and the phase out of the $1 million limit would be raised to $2 million. These amounts would be indexed for inflation. The property and costs eligible for elective section 179 expensing would include tangible section 1245 property and computer software, as under current law.
A separate provision in the draft would require all section 174 research and experimentation (R&E) expenses to be capitalized and amortized over five years, beginning at the midpoint of the year paid or incurred. The discussion draft proposal would, however, make these expenses eligible for expensing under section 179, subject to the overall $1 million limitation.
Another provision in the discussion draft would require 50% of advertising expenses to be capitalized and amortized over five years.
Section 179 expensing would be permitted for the capitalized portion of such advertising expenses.
Qualified real property would no longer be eligible for section 179 treatment.
The amortization period for amortizable section 197 intangibles would be extended from 15 years to 20 years, beginning in the first tax year beginning after 2014, with a credit for the amortization years preceding that.
The section 197 anti-churning rules would be repealed.
The current 15-year safe harbor amortization period for certain non-section 197 intangibles would be changed to a minimum of 20 years. The 20-year safe harbor would be available for capitalized amounts paid to facilitate an acquisition of a trade or business, a change in capital structure, and similar transactions.
Other cost recovery provisions
Like-kind exchange treatment under section 1031 would be repealed.
The discussion draft would repeal current-law provisions allowing expensing of certain film production costs, fertilizer expenditures, handicapped access expenditures, reforestation costs, and energy efficient improvements to a building, as well as accelerated recovery of certain pollution control costs, and certain other incentives.
Tax accounting method provisions
The cash method of accounting would be denied to a broader range of taxpayers and pass-through entities. The $5 million gross receipts test would be increased to $10 million, and indexed for inflation.
A provision in the discussion draft would prohibit the computation of inventory amounts using the LIFO method, the lower of cost or market method, or any method valuing inventory at a bona fide selling price.
The special treatment of home construction contracts under the long-term contract accounting rules would be repealed.
The deductions for certain start-up expenditures and certain organizational expenditures would be consolidated, and the first-year deductible amount would be increased to $10,000.
The discussion draft, as mentioned above, would allow a deduction for only 50% of adverting expenses in the year paid or incurred, and require the remainder to be amortized over five years.
Similarly, all section 174 research and experimental expenditures would be amortized over five years beginning in the year paid or incurred, with a mid-year convention. The five-year period would continue regardless of whether there was a disposition.
Several oil, gas, and mining expenditure provisions would be scaled back. Percentage depletion for mines, wells, natural deposits, and oil and gas wells placed in service after 2014 would be terminated.
Further discussion and description of these provisions will be provided in the next few weeks.
The Finance Committee staff requests comments on the discussion draft by January 17, 2014, though other comments will be accepted. The documents released today make no statements about any specific considerations or further proceedings in the deliberations about tax reform.
For more information, contact a tax professional with KPMG’s Washington National Tax: