Section 179

Article Dean Dorton

This is the first in a five-part series that highlights the segments of the newly enacted Tax Cuts and Jobs Act and how it impacts the real estate industry.

We will focus on the following topics:

  1. Cost recovery and expensing of depreciable assets
  2. 20% deduction for qualified business income
  3. Excess business losses and net operating losses
  4. Business interest expense limitations
  5. Like-kind exchanges, rehabilitation credit, and qualified opportunity zone gain deferral

In our first installment, we will discuss highlights of the Act and how it impacts capitalization and cost recovery of assets.

First, let’s discuss a section of the Act which may impact assets placed in service during the 2017 tax year.

Bonus depreciation

Prior to September 27, 2017, new assets with modified accelerated cost recovery system (MACRS) lives of 20 years or less were eligible for 50% expensing in their first year in service. For assets acquired and placed in service after September 27, 2017, bonus depreciation has been expanded to include used assets (as long as the use is original to the taxpayer) and increased to 100% expensing. This means certain assets can be fully expensed in their year of purchase. Please note that assets that had a written binding contract prior to September 27, 2017will not be eligible for 100% bonus depreciation. Assets purchased from a related party or controlled group, or received through gift or inheritance, are not eligible for bonus depreciation.

Bonus depreciation at 100% of cost will be available for assets placed in service from September 27, 2017 to January 1, 2023. Then it will be phased out over the period from January 1, 2023 to December 31, 2026 and will be fully eliminated after December 31, 2026. Taxpayers will still be able to elect out of bonus depreciation if they choose.

States will have to decide whether they will follow the changes to federal depreciation rules. If they do not follow the federal law, then there will be adjustments for state purposes to be considered in tax planning.

The next two changes only impact assets placed in service after December 31, 2017.

Section 179 expensing

The Section 179 election allows for 100% expensing for eligible assets up to certain annual limits. The limit for expensing annually increases to $1 million for eligible assets placed in service after December 31, 2017. Section 179 expensing is limited based on the amount of total assets placed in service. This “phasedown” has been increased to $2.5 million after December 31, 2017. This election is only allowable up to net taxable income.

Eligible Section 179 property is tangible personal property, computer software and a newly created “qualified real property”. The inclusion of qualified real property will greatly expand the ability to expense fixed asset additions. Qualified real property includes the newly created qualified improvement property (discussed below), as well as certain structural improvements to the nonresidential real property. This includes roofs, HVACs, fire protection and alarm systems, and security systems. Qualifying property has also been expanded to include certain depreciable personal property used to furnish lodging (e.g., beds, refrigerators, ranges, et cetera). There has been no change related to residential rental property’s ability to take Section 179 on tangible personal property.

Qualified improvement property

Previously, there were three types of qualified improvements to real property—qualified leasehold improvements, qualified restaurant improvements, and qualified retail improvements. All three definitions varied and had different implications for the ability to currently expense improvements. The new law provides for a single qualified improvement property. This property is any improvement to the interior portion of a building placed in service after the original building is placed in service, and is effective for assets placed in service after December 31, 2017. Qualified improvement property has a 15-year recovery period (20-year ADS period), which means it will be eligible for the 100% bonus depreciation from January 1, 2018 through December 31, 2022, as well as Section 179 expensing.

We have not discussed the interaction of the new cost recovery options with the tangible asset regulations that were issued in 2014 that provided guidelines on capitalization of assets versus expensing as repairs. These will need to be considered when making elections related to 100% bonus expensing versus Section 179 expensing. There will also be interaction with the 20% deduction for qualified business income and the limitation on interest expense, which we will discuss in further detail in our next installment.

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Article Dean Dorton

In our second installment on the new tax law, we will focus on depreciation-related provisions.

Many of you may have previously benefited from bonus depreciation and Section 179 expensing — tax incentives that have allowed businesses to accelerate deductions quicker than regular depreciation. The new law has increased, extended and modified these tax incentives.

Most of the changes are effective for years beginning after December 31, 2017, but there are some changes that are retroactive to September 27, 2017.

Changes to bonus depreciation

For qualified property acquired and placed in service after September 27, 2017, the new law increases the amount eligible to be immediately expensed to 100% of the purchase price. Additionally, the definition of qualified property is expanded to include used property. Note that used property is eligible for bonus depreciation only if it is the taxpayer’s first use of the property. Meaning, if a business purchases a used piece of equipment, and it is the first use of that piece of equipment for the acquiring business, then the property would qualify for bonus depreciation.

For most qualified property, bonus depreciation will begin phasing-down from 100% expensing starting on January 1, 2023. The phase-down schedule is as follows:

  • 100% for property placed in service after Sept. 27, 2017 and before Jan. 1, 2023
  • 80% for property placed in service during calendar year 2023
  • 60% for property placed in service during calendar year 2024
  • 40% for property placed in service during calendar year 2025
  • 20% for property placed in service during calendar year 2026

It is important to note qualified property that was acquired on or before September 27, 2017, but placed in service after this date will not qualify for 100% expensing under the new law. Property won’t be treated as acquired after September 27, 2017 if a written binding contract was entered into for its acquisition on or before this date. Instead, the pre-Tax Cuts and Jobs Act law on bonus depreciation will be applicable.

Both the old law and new law allow for businesses to elect out of bonus depreciation and depreciate qualified property under regular depreciation rules. For a taxpayer’s first taxable year ending after September 27, 2017, a taxpayer may also elect to use the 50% bonus depreciation rate instead of 100%.

Changes to Section 179 expensing

For taxable years beginning after December 31, 2017, Section 179 expensing is increased to $1,000,000 on up to $2,500,000 of qualifying purchases. Section 179 expensing begins phasing out dollar for dollar for each qualifying purchase over $2,500,000. Unlike bonus depreciation, Section 179 expensing is limited to net trade or business income which means it cannot create a tax loss.

Property eligible for Section 179 expensing includes tangible personal property, computer software and qualified real property. Under the new law, qualified real property has been expanded and includes:

  • Qualified improvement property (defined below)
  • Certain structural improvements made to nonresidential real property placed in service after the date such property was placed in service including:
    • Roofs
    • Heating, ventilation and air-conditioning property (HVACs)
    • Fire protection and alarm systems
    • Security systems

Changes to depreciation provisions for nonresidential real property

In an effort to simplify the tax code, the new tax law condenses the improvement categories (leasehold, retail, and restaurant) which were eligible for special depreciation deductions under the old law into one category called “qualified improvement property”. Qualified improvement property is defined as any improvement to an interior portion of a building which is nonresidential real property if such improvement is placed in service after the date such building was first placed in service. The definition excludes the enlargement of the building, any elevator or escalator, or the internal structural framework of the building.

Qualified improvement property qualifies for a 15 year recovery period using the straight-line method for regular depreciation and is eligible for both bonus depreciation and Section 179 expensing.

The changes noted above are effective for property placed in service after December 31, 2017.

Other changes

There are many more changes made to depreciation-related provisions under the new tax law that we will not detail in this article. Some of these changes include:

  • An increase in the annual caps on luxury automobiles depreciation
  • Specific changes to depreciation of farm property:
    • 200% declining balance method can be used for certain farm property, and
    • farm equipment is now eligible for a 5-year cost recovery period
  • Shorter ADS recovery period for residential rental property
  • Limitations on the use of bonus depreciation for certain businesses with floor plan indebtedness

All of these noted changes are effective after December 31, 2017.

Read Previous Article: Employee Benefits

Article Dean Dorton

Congress finally passed an extenders package that includes some key tax provisions that go beyond 2015. While there are numerous provisions, the ones we are frequently asked about include:

  • Section 179 deduction for up to $500,000 of qualifying business property is made permanent and the amount will be indexed for inflation in future years.
  • Bonus depreciation is extended through 2019 – 50% for 2015, 2016 and 2017, 40% for 2018, and 30% for 2019. And, starting in 2016, improvements to an interior portion of a nonresidential building made after the building was placed in service will also qualify.
  • For S corporations, the period for avoiding the built-in gains tax is “permanently” made 5 years.

What will we do for drama between Thanksgiving and New Year’s next year?

Below are some articles with more information on  the Act’s provisions: