The Tax Cuts and Jobs Act of 2017 (TCJA) brought with it a variety of changes to the laws surrounding depreciation of tangible property and how it can be claimed on a taxpayer’s return in 2017 and beyond. At the forefront of the conversation are items that existed under pre-TCJA law, but were substantially changed with the passing of TCJA. These items include bonus depreciation, Section 179 depreciation and qualified improvement property (QIP).
Before digging into the significant changes made to both bonus depreciation and Section 179 expensing, the Tangible Property Regulations that took effect in 2014 should be applied prior to consideration of MACRS, bonus depreciation or Section 179 expensing. These regulations provide a much higher threshold for improvements requiring capitalization, therefore reducing the complexities that come along with depreciable property.
Bonus depreciation is described as allowable additional depreciation in the year that the property is first placed in service. This additional depreciation is only allowed for qualified property. Although bonus depreciation was part of the pre-TCJA tax law, the passing of TCJA provided various changes, including the following distinct and significant revisions:
- Extended the deadline by which taxpayers were required to place the qualified property into service from December 31, 2019 to December 31, 2026.
- Increased the amount eligible for bonus depreciation from 50% to 100% of the adjusted basis of the qualified property beginning September 27, 2017 and expiring December 31, 2022. From that point on, a phase out of the eligible amount for bonus depreciation exists as follows:
- 80% for property placed in service during the calendar year 2023
- 60% for property placed in service during the calendar year 2024
- 40% for property placed in service during the calendar year 2025
- 20% for property placed in service during the calendar year 2026
- Expanded the definition of qualified property to include used property, whereas pre-TCJA only allowed bonus depreciation on new property.
- One glaring omission in the law was the link between qualified improvement property (discussed later) and bonus depreciation. Previously, the various types of qualified improvement property were given a 15-year recovery period, making the property eligible for bonus depreciation. When the Act was passed through Congress, the code section that makes qualified improvement property 15-year property was erroneously removed. Instead, improvement property must be depreciated over a 39-year recovery period. Spokespersons for the Internal Revenue Service have clarified that they do not have the authority to fix this error; it requires an act of Congress.
On August 6th, the Treasury released proposed regulations that provide several important clarifications. Qualified leasehold, qualified retail and qualified restaurant improvement property placed in service from September 28, 2017 through December 31, 2017 can qualify for 100% bonus depreciation but qualified improvement property (discussed later) will not be qualified for any bonus depreciation after December 31, 2017. For partners interested in buying or selling an interest in a partnership, the proposed regulations indicate that so-called “743 basis adjustments” can qualify for 100% bonus depreciation. These adjustments occur when a partner sells an interest to another partner or a third party. Conversely, when a partner is redeemed by a partnership, the resulting basis adjustment is not eligible for bonus depreciation. This will have major implications on negotiated purchase prices for sales of partnership interests for years to come.
Section 179 Expensing
For property placed in service in taxable years beginning after December 31, 2017, the TCJA expands the amount a taxpayer may expense using Section 179 from $510,000 to $1,000,000 while also increasing the investment limit to $2,500,000. When the amount of qualified property exceeds the $2,500,000 investment limit, the Section 179 deduction is reduced dollar for dollar.
Beyond the changes made to the limitation, the Act expands the definition of Section 179 eligible property to include a few specific items:
- Certain depreciable tangible personal property used predominantly to furnish lodging or in connection with furnishing lodging
- Improvements made to nonresidential real property as long as they are placed in service after the date the building is first placed in service, including roofs, heating, ventilation and air-conditioning property, fire protection and alarm systems and security systems.
Note that unlike bonus depreciation, Section 179 expensing is only available in the event the taxpayer has net income in the year in question prior to taking the deduction under Section 179.
Qualified Improvement Property
Qualified improvement property is defined as any improvement to an interior portion of a building that is nonresidential real property if the improvement is placed in service after the date the building was first placed in service. Exceptions to this definition include improvements for which the expenditure can be attributed to:
- The enlargement of the building
- Any elevator or escalator within the building
- The internal structural framework of the building
Qualified improvement property replaces the separate definitions for qualified leasehold improvements, qualified restaurant property and qualified retail improvement property. This is an overall beneficial change in the tax code from a taxpayer perspective because the definition provides no limitations on what business the property is used in, whether or not the improvement is made pursuant to a lease and eliminates related party limitations. Additionally, there is no requirement as to when the property is placed in service subsequent to the purchase of the building.
As of this writing, the TCJA doesn’t specifically mention qualified improvement property as a type of property that can qualify for bonus depreciation, assuming all other eligibility requirements are met. As a result of this omission, the IRS has communicated that absent any corrective legislation, the IRS will continue to treat qualified improvement property as 39-year property rather than as 15-year property as originally intended.
Application and Planning
Before considering the significant changes made to both bonus depreciation and Section 179 expensing, be aware that the Tangible Property Regulations should be applied prior to consideration of MACRS, bonus depreciation or Section 179 expensing. The first consideration should be to identify items that qualify for a current year deduction under the existing tangible property rules, and then determine the options available for those items that don’t qualify. As previously mentioned, a major consideration when determining whether to apply first-year bonus depreciation or elect the Section 179 expensing rules on purchased property is whether the taxpayer will have taxable income during the year in question. In years when taxable income is not expected, 100% bonus depreciation can be used on the qualifying purchases, creating a loss carryforward that can provide future benefit in years where taxable income is expected. Taxpayers should also keep in mind that the limitation on Section 179 expensing applies per taxpayer, whereas there is no limit to the amount of bonus depreciation that a taxpayer may take.
Between the expiration of bonus depreciation after December 31, 2026 and the ambiguity surrounding the applicability of bonus depreciation to qualified improvement property, this won’t be the last we hear regarding the changes made to depreciation in the Tax Cuts and Jobs Act. As always, please reach out to your Withum tax advisor with any questions regarding the Tangible Property Regulations, bonus depreciation, Section 179 expensing or the new definition of qualified improvement property.
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