Yesterday Senator Ron Wyden (D- OR), Ranking Member of the Senate Finance Committee, unveiled a new proposal to simplify the current cost recovery system. The proposal would alter the schedules businesses use to depreciate their assets.
Current Law
Today’s cost recoveryCost recovery is the ability of businesses to recover (deduct) the costs of their investments. It plays an important role in defining a business’ tax base and can impact investment decisions. When businesses cannot fully deduct capital expenditures, they spend less on capital, which reduces worker’s productivity and wages. rules originate from the TaxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. Reform Act of 1986, which created the Modified Accelerated Cost Recovery System (MACRS). MACRS accelerates the rate at which businesses depreciate their assets for tax purposes relative to straight-line treatment. Machinery and equipment are assigned to one of six depreciationDepreciation is a measurement of the “useful life” of a business asset, such as machinery or a factory, to determine the multiyear period over which the cost of that asset can be deducted from taxable income. Instead of allowing businesses to deduct the cost of investments immediately (i.e., full expensing), depreciation requires deductions to be taken over time, reducing their value and discouraging investment. s lives, as shown below. Residential rental property is depreciated over 27.5 years and commercial rental property is depreciated over 39 years, both under the “straight line method.” This method requires businesses to deduct the same percentage of the costs of their investment each year.
Current Asset Class Assignment
|
Class Life (Years) |
MACRS Recovery Period |
|
4 or less |
3 years |
|
5 to 9 |
5 years |
|
10 to 15 |
7 years |
|
16 to 19 |
10 years |
|
20 to 24 |
15 years |
|
25 or more |
20 years |
Not all assets are subject to these depreciation schedules. Certain foreign-use and tax-exempt property must be depreciated using the slower Alternative Depreciation System (ADS). Corporations must calculate earnings and profits (E&P) under the ADS method, and taxpayers must calculate depreciation under the Alternative Minimum Tax (AMT) as well. Given this vast array of rules, a taxpayer may be required to calculate depreciation for the same asset multiple ways every year. In total, there are more than 100 depreciation schedules.
Creates Asset Pools for Depreciation
Senator Wyden’s proposal would replace the current MACRS and ADS system with the Accelerated Mass Asset Cost Recovery and Reinvestment System (A-MACRRS). A-MACRRS would reduce the depreciation schedules to six asset “pools.” Assets would be assigned to each pool based on their current MACRS property class assignment. Taxpayers would have to calculate depreciation, E&P, and AMT adjustments only once on a unified schedule.
Businesses would transition to this new system by assigning the remaining adjusted basis for their capital assets to each pool. Each pool’s balance would be increased or decreased if any assets were bought or sold that year. Each pool would then be multiplied by its corresponding declining balance percentage to determine that year’s depreciation deductions. These percentages are shown below. For firms that manage large bundles of assets, this pooling system provides a simpler alternative to using the current “mass asset accounts” for depreciation, which impose an additional tax on the disposition of assets.
Proposal
|
Pool |
A-MACRRS Rate |
|
1 |
49% |
|
2 |
34% |
|
3 |
25% |
|
4 |
18% |
|
5 |
11% |
|
6 |
8% |
Reforms Tax Deferral for Dispositions
Under current law, an asset’s adjusted basis is reduced by the amount of previous depreciations claimed by the taxpayer. When the asset is sold, if the proceeds from the sale exceed the asset’s adjusted basis, the gain is taxed at ordinary rates up to the original purchase price and treated as a capital gain on any amount exceeding the purchase price. The tax code provides an exception to this “recapture tax” under what are called “like-kind exchanges.” A taxpayer may defer taxation on those gains if he exchanges that asset for another asset in the same class, as defined by current Treasury regulations. The pooling system would allow personal property to be subject to this deferral as long as the replacement asset is in the same pool as the one that was disposed.
Simplifies “Placed-in-Service” Rules
Assets placed in service at the end of a year’s second quarter can only claim half of their depreciation deduction. Additionally, assets placed in service in the last quarter receive even smaller depreciation deductions under the “mid-quarter” convention. These rules introduce unnecessary complexity and uncertainty into the tax system. The Wyden proposal eliminates both the half-year and mid-quarter conventions, allowing taxpayers to claim the full deduction.
Gives Treasury Authority to Review Depreciation System
In 1988, under the Miscellaneous and Technical Corrections Act, Congress revoked Treasury’s authority to update class lives based on technological changes. This proposal would reinstate the Treasury’s authority to update class lives based on new assessments of an asset’s useful life. The Treasury would be required to conduct a review of the depreciation system and submit a report to Congress every five years.
Other Changes to Cost Recovery
Many taxpayers are subject to special rules for certain kinds of assets. Assets that are used less than 50% for business purposes are subject to the ADS schedule, and the personal use portion is taxable. Taxpayers must keep strict records of business use for “listed property”, assets that could be used for recreational purposes, such as TVs and laptops. “Luxury autos,” vehicles that are not entirely used for business purposes, are also subject to depreciation limitations. The Wyden proposal would remove laptops from “listed property” and simplify the “luxury auto” rules. For assets that are used less than 50% for business purposes, the asset would be assigned to its appropriate pool but a business could only claim the deduction for the business portion of the asset.
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