Depreciation Changes Under Tax Reform
January 11, 2018
The Tax Cuts and Jobs Act (TCJA) has effectively lowered the cost of acquiring capital assets by making substantial changes to the rules for bonus depreciation deductions, Code Sec. 179 expensing deductions and regular depreciation deductions for property used in a business or other income-producing activity.
Before the TCJA taxpayers were allowed to deduct 50% of the cost of most new tangible property (other than buildings and some building improvements) and most new computer software in the year that it was placed in service (with the regular depreciation deductions for that first year and later years allowed but adjusted). For most property, the “50% bonus depreciation” was to be phased down to 40% for property placed in service in calendar year 2018, 30% in calendar year 2019 and 0% in 2020 and afterward.
But effective for property placed in service and acquired after Sept. 27, 2017 (with no written binding contract for acquisition in effect on Sept. 27, 2017), the TCJA raised the 50% rate to 100% (appropriately, 100% bonus depreciation is also called “full expensing” or “100% expensing”). Additionally, the post-Sept. 27, 2017 property eligible for bonus depreciation can be new or used. On the other hand the TCJA repealed the eligibility for bonus depreciation of “qualified improvement property” (certain improvements to buildings other than residential rental buildings) but gave QIP other benefits discussed below.) Under the TCJA, public utility property and property owned by certain vehicle dealerships is for the first time excluded from bonus depreciation.
Note as well that the 2018/2019/2020 phase down of bonus depreciation that applies to most eligible property has been deferred and modified. The 100% figure is to be lowered to 80% for property placed in service in calendar year 2023, 60% in 2024, 40% in 2025, 20% in 2026 and 0% in 2027 and afterward. The one exception is that property will be subject to the 2018/2019/2020 phase down if it is placed in service after Sept. 27, 2017 but acquired before Sept. 28, 2017 (or subject to a written binding contract for acquisition in effect on Sept. 27, 2017).
Code Sec. 179 Expensing
Before the TCJA, taxpayers could expense (deduct the entire cost of) section 179 property up to an annual limit of $500,000 adjusted for inflation. For property placed in service in tax years that begin in 2018, the inflation adjusted limit was scheduled to be $520,000. The annual limit is reduced by one dollar for every dollar that the cost of all section 179 property placed in service by the taxpayer during the tax year exceeds $2 million adjusted for inflation. For property placed in service in tax years that begin in 2018, the inflation adjusted threshold was scheduled to be $2,070,000. But the TCJA, beginning with tax years beginning in 2018, substitutes as the annual dollar limit $1 million (adjusted for inflation for tax years beginning after 2018) and $2.5 million as the phase down threshold (adjusted for inflation for tax years beginning after 2018).
Before the TCJA, section 179 property included most depreciable tangible personal property as well as non-customized (“off-the-shelf”) computer software. But, generally, the only buildings or other land improvements that qualified were, but only by election of the taxpayer, restaurant buildings and certain building improvements to leased space, retail space or restaurant space. The TCJA, for tax years beginning after 2017, eliminated these categories and substituted as an elective category the much broader qualified improvement property category (that is no longer eligible for bonus depreciation, see above). Also, for the first time, taxpayers can elect to treat as section 179 property roofs and, even if they are structural components of a building, heating, ventilation and air conditioning property; fire protection and alarm systems; and security systems. The only requirement is that these roofs and other properties not relate to residential rental buildings.
Other rules for real property depreciation
Under the TCJA, if placed in service after 2017, qualified improvement property, in addition to no longer qualifying for bonus depreciation and becoming newly eligible as section 179 property, has a 15 year depreciation period (rather than the 39 year period that generally applies to non-residential buildings). Note that there is a glitch in the law that doesn’t state the 15 year recovery period for QIP, but it was listed as such in committee and conference reports and a technical correction is expected to address this, perhaps sometime in 2018.
Also, apartment buildings and other residential rental property placed in service after 2017 generally continue to be depreciated over a 27.5 period, but should the taxpayer elect the application of the alternative depreciation system (ADS), or should the property be subject to one of the conditions (for example, tax-exempt financing) that triggers mandatory ADS, the ADS depreciation period is 30 years instead of the pre-TCJA 40 years.
And, for tax years beginning after 2017, if a taxpayer in a real property trade or business elects to not be subject to the TCJA’s limits on business interest deductions, the taxpayer must depreciate all of its depreciable buildings, and its qualified improvement property, under the ADS. What is not yet clear is does this mean assets acquired before 2018 need to be depreciated under ADS or just assets acquired after December 31, 2017 – stay tuned.
The annual dollar caps on depreciation (aggregated with Code Sec. 179 expensing) of passenger automobiles (and smaller vans and trucks treated as passenger automobiles) have been more than tripled by the TCJA. Also, because of the extension of bonus depreciation, the increase of $8,000 in the otherwise-applicable first year cap for passenger automobiles eligible for bonus depreciation is extended through 2026. A phase-down in the $8,000 amount that was scheduled to occur in 2018 and 2019 (with no increase applying after 2019) won’t apply unless the passenger automobile was acquired before Sept. 27, 2017 (or was subject to a written binding contract for acquisition in effect on Sept. 27, 2017).
Computers and Peripheral Equipment
Under the TCJA, computers and peripheral equipment placed in service after 2017 are not treated as “listed property” whether or not they are used in a business establishment (including a home office) or whether or not an employee’s use is for the convenience of an employer. This means that the use doesn’t have to pass a more-than-50% qualified business use test in order to be eligible for Code Sec. 179 expensing and to avoid mandatory application of the ADS.
- With the limitation of business interest, certain businesses may want to not maximize depreciation deductions in order to deduct all of their interest.
- Qualified business income is computed utilizing net income from businesses and one of the limitations is the taxable income of the ultimate taxpayer (an individual or trust), so coordination of depreciation methods and QBI deductions will be warranted.
- Cost segregation studies will still have significant value in 2018 and forward, especially for property where ADS is elected, as well as for qualified improvement property, where there is no longer the opportunity to utilize bonus depreciation.
- It remains to be seen if states will decouple from the new federal depreciation rules, as they have in the past for bonus and enhanced Section 179 depreciation.
Before making any final decisions, we always recommend that you consult with your tax advisor to review options based on your situation. Please contact us if you have any questions as you navigate tax planning.