The president signed into law on Dec. 22, 2017, the Tax Cuts and Jobs Act, which is the most extensive tax reform measure in more than 30 years.
The new legislation makes fundamental changes to the Internal Revenue Code, which created numerous planning opportunities. Perhaps the most impactful change in all the Tax Cuts and Jobs Act was the 100 percent expensing of certain assets. Businesses love it. Economists love it. And CPAs helping their clients really love it. The depreciation upgrade gives taxpayers the ability to expense the asset purchases or a larger portion of the cost to help reduce taxable income. Let’s look at the details below.
Bonus depreciation (the whole pizza)
Bonus depreciation allows you to take a first-year depreciation deduction on qualified depreciable property. Prior to the new tax law, bonus depreciation was 50 percent of the cost of assets placed in service in 2017 and was scheduled to phase-out and decrease to 40 percent in 2018. The main qualifications for bonus depreciation were that the property had to be new and have an asset life of 20 years or less.
The new tax law made two significant changes to bonus depreciation. First, it increased bonus depreciation to 100 percent for assets placed in service after Sept. 27, 2017. The second change is that used assets now also qualify (previously only new assets qualified). This inclusion of used assets greatly expands the taxpayers’ ability to write off assets completely in the year purchased. If you elect bonus on your five-year property you must apply to all five-year property. So, electing bonus is like eating the whole pizza, you can’t just expense one slice.
Section 179 (Just a slice)
Section 179 allows you to deduct the cost of certain qualifying property that otherwise would be depreciated. Section 179 has certain limitations that must be applied. The amount of section 179 that can be elected in 2018 is subject to a maximum annual deduction of $1 million, which will be phased down if total property acquired during the year exceeds the annual threshold of $2.5 million. The amount of section 179 taken on your return is also limited by taxable income. Unlike bonus, section 179 offers more flexibility by allowing taxpayers to pick and choose which slice of the pizza they would like. If you purchase two (five-year life) pieces of equipment, you could elect section 179 on one and not the other. This can be beneficial in managing your taxable income. For example, strategic depreciation deductions allow you to maximize eligibility for the new 20 percent Qualified Business Income deduction (see Opsahl Dawson column in Jan. 19, 2018, VBJ).
The new tax law also expanded the definition of qualifying property eligible for section 179. The addition to qualifying property includes:
Qualified real property, such as:
- Qualified improvement property (discussed below)
- Following improvements to nonresidential real property:
- HVAC property
- Fire protection and alarm systems
- Security systems
- Personal property used with the furnishings of rental properties
- Qualified improvement property (the commercial real-estate investors best friend)
The new tax law simplifies previous categories of building improvement property and Qualified Leasehold Improvements. Starting with assets placed in service Jan. 1, 2018, there will be one category known as qualified improvement property (QIP). QIP is defined as any improvement made to an interior portion of a nonresidential building after the date the building was first placed in service. QIP excludes an enlargement to a building, elevators and escalators, and costs attributable to the internal structural framework of a building.
QIP is depreciated over a 39-year life and is eligible for section 179. A qualifying building improvement once taken over 39 years now has potential to be fully deducted in the year of the improvement. The original intent for the QIP was to change the class to a 15-year life but due to a drafting error, it is still in the code as 39-year life. We are still waiting for technical corrections.
We recommend looking at your current situation and strategizing with your CPA to evaluate potential cost segregation studies for your business or commercial property. Take this opportunity to further analyze how the depreciation upgrade affects you.
Kelsey Elwess is a CPA manager with Opsahl Dawson in Vancouver. She has been with Opsahl Dawson since 2011.