Section 167(f)(1) provides that capitalized computer software costs, other than computer software to which section 197 applies, are recovered ratably over 36 months.  

In lieu of depreciation, a taxpayer with a sufficiently small amount of annual investment generally may elect to deduct up to $24,000 (for taxable years beginning in 2001 or 2002) of the cost of qualifying property placed in service for the taxable year (sec. 179).  This amount is increased to $25,000 for taxable years beginning in 2003 and thereafter.  In general, qualifying property is defined as depreciable tangible personal property that is purchased for use in the active conduct of a trade or business.  

Explanation of Provision

The provision allows an additional first-year depreciation deduction equal to 30 percent of the adjusted basis of qualified property.  The additional first-year depreciation deduction is allowed for both regular tax and alternative minimum tax purposes for the taxable year in which the property is placed in service.²  The basis of the property and the depreciation allowances in the year of purchase and later years are appropriately adjusted to reflect the additional first-year depreciation deduction.  In addition, the provision provides that there would be no adjustment to the allowable amount of depreciation for purposes of computing a taxpayer's alternative minimum taxable income with respect to property to which the provision applies.  A taxpayer is allowed to elect out of the additional first-year depreciation for any class of property for any taxable year.

In order for property to qualify for the additional first-year depreciation deduction it must meet all of the following requirements.  First, the property must be property to which the general rules of MACRS³ apply with (1) an applicable recovery period of 20 years or less, (2) water utility property (as defined in section 168(e)(5)), (3) computer software other than computer software covered by section 197, or (4) qualified leasehold improvement property ⁴.  Second, the original use⁵ of the property must commence with the taxpayer on or after September 11, 2001.⁶ 

For purposes of the provision, a binding commitment to enter into a lease would be treated as a lease, and the parties to the commitment would be treated as lessor and lessee.  A lease between related persons would not be considered a lease for this purpose.  

Finally, New York Liberty Zone qualified leasehold improvement property is not eligible for the additional first year depreciation deduction.

Third, the taxpayer must purchase the property within the applicable time period.  Finally, the property must be placed in service before January 1, 2005.  An extension of the place in service date of one year (i.e., January 1, 2006) is provided for certain property with a recovery period of ten years or longer and certain transportation property.⁷  Transportation property is defined as tangible personal property used in the trade or business of transporting persons or property.

The applicable time period for acquired property is (1) after September 10, 2001 and before September 11, 2004, and no binding written contract for the acquisition is in effect before September 11, 2001 or (2) pursuant to a binding written contract which was entered into after September 10, 2001, and before September 11, 2004.  With respect to property that is manufactured, constructed, or produced by the taxpayer for use by the taxpayer, the taxpayer must begin the manufacture, construction, or production of the property after September 10, 2001, and before September 11, 2004.  Property that is manufactured, constructed, or produced for the taxpayer by another person under a contract that is entered into prior to the manufacture, construction, or production of the property is considered to be manufactured, constructed, or produced by the taxpayer.  For property eligible for the extended placed in service date, a special rule limits the amount of costs eligible for the additional first year depreciation.  With respect to such property, only the portion of the basis that is properly attributable to the costs incurred before September 11, 2004 ("progress expenditures") shall be eligible for the additional first year depreciation.⁸  

The limitation on the amount of depreciation deductions allowed with respect to certain passenger automobiles (sec. 280F of the Code) is increased in the first year by $4,600 for automobiles that qualify (and do not elect out of the increased first year deduction).   The $4,600 increase is not indexed for inflation.

The following examples illustrate the operation of the provision. 

EXAMPLE 1. – Assume that on March 1, 2002, a calendar year taxpayer acquires and places in service qualified property that costs $1 million.  Under the provision, the taxpayer is allowed an additional first-year depreciation deduction of $300,000.  The remaining $700,000 of adjusted basis is recovered in 2002 and subsequent years pursuant to the depreciation rules of present law.

EXAMPLE 2. – Assume that on March 1, 2002, a calendar year taxpayer acquires and places in service qualified property that costs $50,000.  In addition, assume that the property qualifies for the expensing election under section 179.  Under the provision, the taxpayer is first allowed a $24,000 deduction under section 179.  The taxpayer then is allowed an additional first-year depreciation deduction of $7,800 based on $26,000 ($50,000 original cost less the section 179 deduction of $24,000) of adjusted basis.  Finally, the remaining adjusted basis of $18,200 ($26,000 adjusted basis less $7,800 additional first-year depreciation) is to be recovered in 2002 and subsequent years pursuant to the depreciation rules of present law. 

Effective Date

The provision applies to property placed in service after September 10, 2001.  

²  The additional first-year depreciation deduction is subject to the general rules regarding whether an item is deductible under section 162 or subject to capitalization under section 263 or section 263A.

³  A special rule precludes the additional first-year depreciation deduction for property that is required to be depreciated under the alternative depreciation system of MACRS.

⁴   Qualified leasehold improvement property is any improvement to an interior portion of a building that is nonresidential real property, provided certain requirements are met.  The improvement must be made under or pursuant to a lease either by the lessee (or sublessee) of that portion of the building, or by the lessor of that portion of the building.  That portion of the building is to be occupied exclusively by the lessee (or any sublessee).  The improvement must be placed in service more than three years after the date the building was first placed in service.

⁵   The term "original use" means the first use to which the property is put, whether or not such use corresponds to the use of such property by the taxpayer.  It is intended that, when evaluating whether property qualifies as "original use," the factors used to determine whether property qualified as "new section 38 property" for purposes of the investment tax credit would apply.  See Treasury Regulation 1.48-2.  Thus, it is intended that additional capital expenditures incurred to recondition or rebuild acquired property (or owned property) would satisfy the "original use" requirement.  However, the cost of reconditioned or rebuilt property acquired by the taxpayer would not satisfy the "original use" requirement.  For example, if on February 1, 2002, a taxpayer buys from X for $20,000 a machine that has been previously used by X.  Prior to September 11, 2004, the taxpayer makes an expenditure on the property of $5,000 of the type that must be capitalized.  Regardless of whether the $5,000 is added to the basis of such property or is capitalized as a separate asset, such amount would be treated as satisfying the "original use" requirement and would be qualified property (assuming all other conditions are met).  No part of the $20,000 purchase price would qualify for the additional first year depreciation.

⁶  A special rule applies in the case of certain leased property. In the case of any property that is originally placed in service by a person and that is sold to the taxpayer and leased back to such person by the taxpayer within three months after the date that the property was placed in service, the property would be treated as originally placed in service by the taxpayer not earlier than the date that the property is used under the leaseback.

⁷  In order for property to qualify for the extended placed in service date, the property is required to have a production period exceeding two years or an estimated production period exceeding one year and a cost exceeding $1 million.

⁸   For purposes of determining the amount of eligible progress expenditures, it is intended that rules similar to sec. 46(d)(3) as in effect prior to the Tax Reform Act of 1986 shall apply.