There are some significant opportunities in the new depreciation rules produced by the tax reform overhaul known as, “The Tax Cuts and Jobs Act.” Many of these changes will allow your real estate business to write off all or significant portions of your capital purchases in year one. The majority of these rules are effective for tax years beginning after December 31, 2017. However, some could provide significant benefits to your 2017 tax returns, and we will monitor this closely.
Bonus depreciation has been increased to 100% for qualifying property acquired and placed in service after September 27, 2017. There are some complex transition rules that will need to be evaluated, but pay close attention to your 2017 tax returns, as this could be extremely beneficial. The percentage allowed will be reduced 20% per year starting in 2022. One of the highlights of (the most beneficial provisions of) this legislation is that used property purchased by the taxpayer qualifies for bonus depreciation in 2018 and beyond. This will make cost segregation studies even more favorable.
Qualified Improvement Property
Previously, we had a two-part test to determine the depreciable life of certain commercial tenant improvements. We had to first determine the life, which would be either 39-year non-residential property or 15-year Qualified Leasehold Improvement Property (QLHI). We then had to determine if the cost qualified for bonus depreciation as Qualified Improvement Property (QIP). The definition for qualified improvement property has now been simplified and expanded. QIP now has a 15-year life and is eligible for bonus depreciation. One item to note, however, is that the tax act intended to include these rules, but unintentionally left them out. A technical correction is required to bring into law the bonus depreciation and 15-year life for QIP.
The expensing amount has increased to $1 million with a phase-out limitation of $2.5 million. Additionally, the IRC 179 qualified property has been expanded for qualifying real property which includes QIP (described above), roofs, HVAC, fire protection and security systems. The restriction on property with lodging facilities has also been eliminated.
Certain taxpayers are required to use the alternative depreciation system (ADS), and some taxpayers elect to use it. Additionally, these rules may become more important due to the election described below. Previously, ADS lives were 40 years for residential and non-residential/commercial real estate. Going forward, residential real estate has been reduced to 30 years while non-residential/commercial real estate remains at 40 years.
Business Interest Limitation Election
Within “The Tax Cut and Jobs Act,” there is a new business interest limitation which effectively limits a business' interest expense to 30% of its adjusted taxable income. Real property trades or businesses that make an irrevocable election are exempt from this interest limitation. If you make this election, you will still be able to deduct all of your interest but will be subject to a slower depreciable life (ADS Depreciation described above) on certain asset classes. There are still many questions with this election, but you should consider reaching out to your engagement team at DGC to determine if the interest expense or the faster depreciation will be more beneficial to your business.
While there are many opportunities in these new rules, there are many areas where a taxpayer could make a costly mistake. We will monitor for any additional guidance from the IRS, and how individual states apply these rules.
To further discuss these changes or any other issues and concerns related to tax reform, please contact a member of your DGC engagement team, or David Sanchez at 781-937-5156 / firstname.lastname@example.org and Patrick Bevington, CPA, MST at 781-937-5365 / email@example.com.