One of the Code’s more misleading terms has been the heading of Sec. 280F: “Limitation on depreciation for luxury automobiles” and, consequently, the name “luxury auto caps” commonly applied to the provision’s limits.
For years, these caps have belied their name by imposing economy-range limits on depreciation and expensing on passenger automobiles used in businesses. Until, that is, the law known as the Tax Cuts and Jobs Act (TCJA), P.L. 115-97, raised these caps to a level more worthy of the name. For automobiles placed in service in 2018 and following, the TCJA roughly tripled the luxury auto caps, increasing allowable depreciation within the recovery period to levels approaching what might actually be considered the cost of some luxury models. Consequently, if CPAs haven’t done so already, they should discuss with their business clients these more favorable rules for purchasing or leasing autos used in business. Their clients will no doubt thank them (and their local car dealers probably won’t mind, either).
Prices outpace luxury caps
Sec. 280F(a) imposes limits on depreciation or expensing under Sec. 179 for a passenger automobile predominantly (greater than 50%) used in business, with specific dollar limits for each year in the recovery period. For any basis still unrecovered after the recovery period, there is also an annual limitation on any amount treated as an expense during any tax year after the end of the recovery period. A passenger automobile for these purposes is any four-wheel vehicle for use on public thoroughfares of no more than 6,000 pounds unloaded gross vehicle weight, or, for a truck or van, simply gross vehicle weight (Sec. 280F(d)(5)(A)). Thus, the luxury auto caps also apply to “light” trucks and vans. “Heavy” sport utility vehicles (SUVs), i.e., those with a rated weight of more than 6,000 pounds, are therefore exempt but possibly face a Sec. 179 expensing limitation described below.
When Sec. 280F was enacted in 1984, the caps were $4,000 for the first tax year and $6,000 for each succeeding year. Considering that a Toyota Corolla in 1984 had an original manufacturer’s suggested retail price (MSRP) of $6,498, those caps could still leave room for a considerably bigger-ticket auto to be fully depreciated within a few years.
The Tax Reform Act of 1986, P.L. 99-514, harmonized the luxury auto caps with the five-year class life for autos under the then-new modified accelerated cost recovery system (MACRS), under which cars and trucks were included with property having a five-year recovery period. It provided caps of $2,560 for the first year of the recovery period, $4,100 for the second year, $2,450 for the third year, and $1,475 for each succeeding year.
Throughout the history of Sec. 280F, these figures have been adjusted for inflation by the “automobile component” of the consumer price index for urban consumers (CPI-U) (but for vehicles placed in service after 2018, this component of the “chained” CPI-U applies). The Bureau of Labor Statistics (BLS) publishes a “new vehicles index” as a component of the CPI-U, which appears to correspond to an “automobile component.” In addition to price changes, the index reflects a “quality adjustment” for any given model that takes into consideration changes from one year to the next in “reliability, durability, safety, fuel economy, maneuverability, speed, acceleration/deceleration, carrying capacity, and comfort or convenience.” The new vehicles index has risen about 43% from 1984 to 2017. At the same time, according to kbb.com, the original MSRP for a 2017 Toyota Corolla when new was $19,400, a nearly 200% increase from the 1984 price cited above.
Meanwhile, the Sec. 280F(a) caps rose by 23%–27% between 1984 and 2017, depending on which year in the recovery period is compared. What caused these seeming discrepancies between price, CPI index, and the Sec. 280F(a) caps is unclear, but what is clear is that for the 2017 tax year, the maximum depreciation or expensing amounts under Sec. 280F were $3,160 for the first year, $5,100 for the second year, $3,050 for the third year, and $1,875 for each succeeding year (or, if less, the applicable MACRS percentage).
The half-year convention generally applies to five-year MACRS property, meaning that only half of the full-year MACRS depreciation is allowable for the first year the property is placed in service. Because the convention also treats the property as having been placed in service at midyear, the MACRS recovery period is effectively six years. Consequently, for a passenger auto placed in service in 2017, the luxury auto caps would allow a maximum total of $16,935 depreciation to be taken in the six-year period.
TCJA resets the caps
Absent the TCJA, due to the luxury auto caps, the $19,400 Corolla placed in service in 2017 that was used 100% for business might still have an unrecovered basis of $2,465 at the end of its MACRS recovery period (of which only $1,875 could be claimed as an expense per tax year after that period). Because the TCJA boosted these amounts, however, an auto placed in service in 2019 would be allowed up to $53,180 in total depreciation during the MACRS period (see table, “Luxury Auto Caps, 2017 and 2019”). At that rate, a business owner could almost deduct the full cost of a 2019 BMW 530i (base MSRP $53,400) used 100% for business during the MACRS period.
Luxury auto caps, 2017 and 2019
| Depreciation year | MACRS percentage | 2017 caps | 2019 caps |
|---|---|---|---|
| 1 | 20% | $3,160 | $10,100 |
| 2 | 32% | 5,100 | 16,100 |
| 3 | 19.2% | 3,050 | 9,700 |
| 4 | 11.52% | 1,875 | 5,760 |
| 5 | 11.52% | 1,875 | 5,760 |
| 6 | 5.76% | 1,875 | 5,760 |
| Totals | 100% | $16,935 | $53,180 |
Bonus depreciation
The TCJA also increased the Sec. 168(k) first-year depreciation (bonus depreciation) percentage to 100% for property placed in service after Sept. 27, 2017, and before Jan. 1, 2023. A pre-TCJA $8,000 luxury auto cap on bonus depreciation remains in place (Sec. 168(k)(2)(F)(i)). This is added to regular depreciation, for an effective first-year auto cap for 2019 of $18,100.
Heavy SUVs, as noted above, are not subject to the luxury auto caps. Therefore, if the heavy SUV is eligible for bonus depreciation and the taxpayer does not elect out, a 100% depreciation deduction can be taken for the vehicle in the first year.
Heavy SUVs that weigh 14,000 pounds or less, for which owners elect out of bonus depreciation, or that are ineligible for it, generally can be expensed under Sec. 179(b)(5)(A) for up to $25,000 in any tax year (inflation-adjusted to $25,500 for 2019). And, again, these vehicles are not subject to the luxury auto caps. Heavy SUVs that weigh more than 14,000 pounds are not subject to the Sec. 179 expense limitation.
Example: X purchases for $60,000 a heavy SUV with a gross vehicle weight of 9,000 pounds and places it in service in the 2019 tax year. The SUV is eligible for bonus depreciation in 2019. If X does not elect out of bonus depreciation, the full $60,000 cost can be taken as a depreciation deduction. If X elects out of bonus depreciation, X can take a Sec. 179 expense deduction for $25,500 and take a MACRS depreciation deduction based on the remaining cost basis after the Sec. 179 deduction — $34,500. If the SUV instead weighed over 14,000 pounds, and X elected out of bonus depreciation, subject to the overall Sec. 179 expense deduction limits, X could take a Sec. 179 deduction for the full $60,000 cost of the vehicle.
Income inclusion for leasing has a higher exemption amount
For businesses that lease autos long term instead of purchasing them, the TCJA delivered some good news as well. Sec. 280F(c)(2) imposes a limit on deductions taxpayers may take for leasing expense, expressed as an allowable percentage of the expense that is “substantially equivalent” to the luxury auto purchase caps (Sec. 280F(c)(3)). Regs. Sec. 1.280F-7(a) provides guidance on a procedure for a corresponding income inclusion amount of the lease payments, based on the fair market value (FMV) of the auto in the tax year in which it is used under a lease, prorated by the number of days of the lease term that are included in the tax year, multiplied by the percentage of business use (if less than 100%). The IRS publishes tables of inclusion amounts. The most recent is in Rev. Proc. 2019-26, Table 4, which shows no income inclusion for a vehicle with an FMV of $50,000 or less. For 2017 leases (Rev. Proc. 2017-29, Table 5), the lease inclusion began with an FMV over $19,000.
General utility matters, too
Most business owners probably aren’t really seeking luxury; they just want to get a job done that involves automotive transportation. The examples of luxury vehicles given here are therefore probably not especially relevant to the usual tasks of business: light-duty pickup and delivery, getting personnel and equipment to and from a job site, and the like. Vehicles for these purposes may in many cases cost more than a family sedan, however, due to special needs and heavy-duty equipment options for high mileage, wear, and prolonged use. So, despite the name, the raising of the luxury auto caps can have helpful effects for the workaday kinds of driving most business owners do.
The important thing is that these owners know about these higher limits and can plan their purchases, business expansions, or new activities accordingly. No cost/benefit analysis of a purchase is complete without including the tax implications, including depreciation and expensing, whatever the vehicle type or the business’s size or nature. That’s where a word from CPA tax advisers can go a long way toward getting business clients further along the road to financial security and success.
— Paul Bonner is a senior editor with the Association’s Magazines &
Newsletters team. To comment on this article or to suggest an idea for another
article, contact him at Paul.Bonner@aicpa-cima.com.