The Tax Cuts and Jobs Act (TCJA or the Act) made many changes to the depreciation and expensing rules for business assets.
- Businesses may take 100% bonus depreciation on qualified property both acquired and placed in service after Sept. 27, 2017, and before Jan. 1, 2023.
- Full bonus depreciation is phased down by 20% each year for property placed in service after Dec. 31, 2022, and before Jan. 1, 2027.
- Qualified property is defined as tangible personal property with a recovery period of 20 years or less.
- The requirement that the original use of the qualified property begin with the taxpayer was eliminated.
- Qualified leasehold improvement property was removed from the definition of qualified property for property placed in service after Dec. 31, 2017.
The legislation attempted to simplify the bonus depreciation rules for qualified improvement property (QIP); although, due to a drafting error, the final statutory language does not reflect the congressional intent. The Act removed QIP from the definition of qualified property for bonus depreciation purposes, but the intent was to make QIP bonus-eligible by virtue of a 15-year recovery period. In the end, the 15-year recovery period for QIP was omitted from the final legislation. Treasury has made clear this issue must be resolved by Congress. At this time, it does not appear that a technical correction bill will be enacted. Accordingly, QIP remains subject to a 39-year life.
- Qualified property does not include property used in providing certain utility services if the rates for furnishing those services are subject to ratemaking by a governmental entity or instrumentality or by a public utility commission, any property used in a trade or business that has floor plan financing indebtedness or property used in a real property trade or business that makes an irrevocable election out of the interest expense deduction limitation.
- Businesses can still elect, on an annual basis, not to claim bonus depreciation for any class of property placed in service during the tax year.
Applicable recovery periods for real property
- The ADS recovery period for residential rental property was reduced to 30 years from 40 years.
- The separate definitions of qualified leasehold improvement, qualified restaurant and qualified retail improvement property were eliminated.
- A real property trade or business that elects out of the interest expense deduction limitation must use ADS to depreciate nonresidential real property, residential rental property and QIP.
Expansion of section 179 expensing
- The maximum amount a taxpayer may expense under section 179 increased to $1 million and the investment limit (also referred to as the total amount of equipment purchased or phaseout threshold) increased to $2.5 million.
- The definition of section 179 property was expanded to include certain depreciable tangible personal property used predominately to furnish lodging or in connection with furnishing lodging (i.e., beds or furniture used in hotels and apartment buildings).
- The definition of qualified real property for section 179 purposes was expanded to include any of the following improvements made to nonresidential real property: roofs, heating, ventilation and air-conditioning property, fire protection and alarm systems and security systems as long as the improvements are placed in service after the date the building was first placed in service.
- Bonus versus section 179. Consideration and comparison of bonus depreciation and section 179 is critical in planning for depreciation deductions. Unlike section 179 expensing, taxpayers do not need net income to take bonus depreciation deductions. Further, bonus depreciation is not limited to smaller businesses or capped at a certain dollar level as under section 179, where larger businesses that spend more than the investment limitation on equipment will not receive the deduction.
- Used property. Including used property in the definition of qualified property for bonus depreciation has a potentially significant impact on M&A restructuring as bonus depreciation now applies to qualified property acquired in a taxable acquisition.
- Cost segregation studies. Consideration of a cost segregation study is now more important than ever. A cost segregation study is an in-depth analysis of the costs associated with the construction, acquisition or renovation of owned or leased buildings for proper tax classification and identification of assets that may be eligible for shorter tax recovery periods resulting in accelerated depreciation deductions. The reclassification of assets from longer to shorter tax recovery periods may also make these assets eligible for bonus depreciation resulting in even more substantial present value tax savings, especially with full expensing for qualified property placed in service after Sept. 27, 2017. Tangible personal property identified in the cost segregation of acquired property placed in service after Sept. 27, 2017, will now be qualified property for bonus depreciation purposes since the definition of qualified property was expanded to include used property.