By: Amanda Wilson
Last month, President Trump signed into law the much publicized Tax Cut and Jobs Act. In part of our ongoing series discussing the changes made by the Act, the following discusses key changes made to the expensing and depreciation rules. These changes will be a boon for many taxpayers.
The Act provides for 100% bonus depreciation in the year that tangible personal property (excluding buildings and building improvements, although other beneficial treatment is now provided for these assets as discussed below in 2 and 3) and computer software is placed in service. This allows for full cost recovery in the year of acquisition, in contrast to the prior rule of 50% recovery. This rule applies for property acquired and placed in service after September 27, 2017. Another key change is that a taxpayer can now qualify for bonus depreciation when it acquires used property. The bonus depreciation starts phasing out in 2023.
Section 179 Expensing
Section 179 allows taxpayers to expense (i.e., deduct) the entire cost of Section 179 property in the year of acquisition, up to an annual limit, rather than depreciating the property. The Act doubled the amount that can be expensed in a year from $500,000 to $1 million. The $1 million limit is phased out on a dollar for dollar basis for each dollar that the taxpayer’s Section 179 property exceeds $2.5 million. Section 179 property includes most depreciable tangible personal property, off the shelf computer software, and qualified real estate improvements. The Act adds that qualified real estate improvements now includes the following improvements made to non-residential real property: roofs, HVAC systems, fire protection and alarm systems, and security systems.
Tangible property is generally depreciated under the modified accelerated cost recovery system, or MACRS. While the Act leaves largely untouched the MACRS rules, it does provide a benefit for qualified improvements to non-residential real property. In addition to qualifying for Section 179 expensing as discussed above, these qualified improvements now qualify for a 15 year depreciation period, as compared to the 39 year period that generally applies to non-residential real estate.
In the residential real estate area, the traditional depreciation recovery period of 27.5 year under MACRS continues to apply, unless the taxpayer either elects into or is forced into the alternative depreciation system (“ADS”). As a background note, ADS provides for straight line depreciation, as compared to the more accelerated depreciation methods available under MACRS, and is generally less favorable to taxpayers. A taxpayer can be forced into ADS where the property is used predominately outside the U.S., is tax-exempt use property, or is financed with tax-exempt bonds. The Act reduces the ADS depreciation period for residential real estate from 40 years to 30 years.
Finally, the Act imposes new limitations on a business’s ability to claim interest deductions. Specifically, taxpayers generally can no longer deduct net interest expense in excess of 30% of a business’s adjusted taxable income. The Act allows taxpayers in a real estate business to elect out of the interest deduction limitation. The trade-off, though, is that if a taxpayer makes such an election, the taxpayer must now depreciate all of its depreciable buildings and qualified improvements under the less favorable ADS. It is not clear if this applies to all buildings and improvements, or only those acquired and placed in service after December 31, 2017. We expect further guidance on this last point and will update you once we have it.