In one of the most sweeping changes to the U.S. tax code in more than 30 years, the Tax Cuts and Jobs Act (TCJA) has again transformed the landscape of taxation and altered how we apply the tax code to our businesses and individual lives. One of the more meaningful changes for the real estate industry is the extension and expansion of the “special allowance for certain property” provision, most commonly referred to as bonus depreciation. Bonus depreciation is a valuable tax-saving tool for businesses, as it allows a business to accelerate the deduction for qualified property in the year of purchase. This provision in the code, originally introduced by the Economic Security and Recovery Act of 2001, has been consistently altered and extended since its enactment. The TCJA not only extends the provision until December 31, 2026, but also increases the applicable percentage amount from 50 percent to 100 percent.
Dates & Applicable Percentage by Year
As was the case in the last adjustment to the bonus depreciation provision in the Protecting Americans from Tax Hikes Act of 2015 (PATH Act) there’s a phasedown of the applicable percentage over the course of several years. Here’s the phase-down schedule provided by the TCJA:
- 100 percent for property placed in service after September 27, 2017, and before January 1, 2023
- 80 percent for property placed in service during calendar year 2023
- 60 percent for property placed in service during calendar year 2024
- 40 percent for property placed in service during calendar year 2025
- 20 percent for property placed in service during calendar year 2026
In addition to the “placed-in-service” requirement for assets purchased or constructed, there’s an additional requirement the asset must be “acquired” in the applicable time periods above. This raises issues with assets placed in service during the small window in tax year 2017 from September 28 to December 31. If an asset was acquired by a taxpayer before September 28, 2017, and placed in service before December 31, 2017—or in 2018—it won’t qualify for 100 percent bonus depreciation. It would instead be subject to 50 percent bonus depreciation under the provisions of the PATH Act. In general, an asset is considered acquired after the date on which a written binding contract is entered into for such acquisition.
Qualified Property Changes
An additional change to bonus deprecation is the expanded definition of qualified property. Since its inception, bonus depreciation has only been allowed for so-called “new” or “original-use” property. The TCJA has eliminated the original-use provision and now requires the property to not have been used by the taxpayer at any time prior to its current acquisition, effective for property acquired after September 27, 2017. The change to the original-use provision offers significant tax savings benefits to businesses that invest heavily in fixed assets. This is especially true for businesses that purchase real estate. In the past, if a business purchased an existing nonresidential real property and performed a cost segregation study, the maximum benefit would be the accelerated depreciation from 39-year to 5-, 7- and 15-year property. With the removal of the original-use provision, a business could now receive an immediate 100 percent deduction for property that was classified as 5-, 7- and 15-year property in the cost segregation study. This change in the tax law has provided enhanced value to cost segregation studies and should be discussed with your tax advisor as a potential planning opportunity. Along with the change in the original-use provision, the property must meet these requirements:
- Property is not acquired from a related person
- Property is not acquired from a member of a controlled group
- Property is not acquired in a carryover basis transaction or from a decedent
- The basis of the acquired property follows the “cost” rules of Internal Revenue Code Section 179, i.e., the cost cannot include the basis of traded-in property previously held by the taxpayer
Along with the expansion of the qualified property definition comes some additional exclusions. Due to the new interest limitation rules enacted by TCJA, there are certain ineligible trades or businesses that cannot take bonus depreciation. These ineligible businesses include:
- Certain regulated public utilities
- Businesses that use floor plan financing indebtedness, e.g., car dealerships
- Electing real property trade or business (qualified improvement property only)
- Electing farming business (property with 10-year or more recovery period)
Qualified Improvement Property
One of the additional tax law changes included in TCJA relates to qualified improvement property (QIP). Before the TCJA was passed, QIP was defined as any improvement to an interior portion of a building that’s considered nonresidential real property if the improvement is placed in service after the date the building was first placed in service. QIP didn’t include any improvement for which the expenditure was attributed to the enlargement of the building, any elevator or escalator or the building’s internal structural framework. Prior to the TCJA, QIP qualified for bonus depreciation and was depreciable over 39 years. The TCJA has kept the basic framework of QIP, and it remains qualified for bonus depreciation; however, it’s now depreciable over 15 years. In addition to the change in depreciable life for QIP, the new law also eliminates the separate definitions for qualified leasehold improvement property, qualified restaurant improvement property and qualified retail improvement property.
While the above change is what was intended by Congress and explained in the committee reports, the legislative text of the TCJA didn’t specifically assign a 15-year depreciable life to QIP. In addition to not assigning the shorter life, the text of the TCJA also removed the specific mention of QIP as a type of property that, if other requirements are satisfied, is qualified property eligible for bonus depreciation. Because of these two issues with the new law, it’s been interpreted that the legal text provides a 39-year recovery period and no bonus depreciation for QIP. In response to concerns from practitioners over this issue, government officials at an American Bar Association meeting indicated that QIP placed in service on or before December 31, 2017, will qualify for bonus depreciation. That said, unless corrective legislation or regulations are written, starting January 1, 2018, any improvement to the interior portion of a building will be depreciable over 39 years and won’t qualify for bonus depreciation.
The ability to accelerate deductions for property purchased or constructed can provide crucial tax savings to business and property owners. The coordination of the bonus depreciation rules with other new provisions enacted by the TCJA can be complex and requires time and effort to make sure every aspect of the new law is fully understood. The benefits of this new law will vary based on each taxpayer’s facts and circumstances.
If you have questions about how this new tax law will affect your organization or to discuss your specific situation and identify planning opportunities, contact Taylor or your trusted BKD advisor.