Some of the basics….

Section 179 and Bonus Depreciation

Enacted late-December 2017, the Tax Cuts and Jobs Act (TCJA) of 2017 provides revised provisions for expensing under Section 179 and establishes “100% Bonus Depreciation” through 2022.

Expensing acquired assets under Section 179

Under Section 179 of the Internal Revenue Code, businesses (tax paying customers in the U.S.) may elect to take an expense deduction on their 2018 tax return for the full purchase price of qualifying assets acquired in 2018, whether purchased outright for cash, financed, or leased. However, the election is subject to the following limitations:

1. There is a dollar limitation. The maximum deduction available to take in 2018 is $1,000,000.
2. If more than $2,500,000 worth of Section 179 property is placed into service during 2018, the Section 179 deduction is reduced, dollar for dollar, by the amount exceeding the 2018 threshold of $2,500,000. As a result, the Section 179 dollar limit would be reduced to zero if property worth $3,500,000 or more was placed into service in 2018.

(Note: Even though the Section 179 deduction is reduced, purchased assets can still be expensed under the Bonus Depreciation rules.)

3. The Section 179 deduction for any tax year may not exceed taxable income for that year. If, for example, net taxable income was $172,000 in 2018, the Section 179 deduction cannot exceed $172,000 for 2018. However, the amount of Section 179 deduction not allowed by this limitation can be carried over to the next year.

With the passage of the Tax Cuts and Jobs Act of 2017, the dollar limitation for 2018 was raised by $500,000, as well as, the threshold increased by $500,000. For tax years following 2018, the dollar limitation and threshold amounts will be adjusted for inflation.

 Depreciating acquired assets under the Bonus Depreciation rules

Under Section 167 of the Internal Revenue Code, the full purchase price of acquired assets is capitalized and expensed by claiming depreciation deductions over several years, beginning in the year of acquisition.

But for assets acquired in 2018, the Bonus Depreciation rules allow businesses to compute their 2018 depreciation deduction by taking the full purchase price and deducting the entire amount in the year property is placed in service. This 100% deduction is only eligible in the year the asset is first placed in service; the asset is regarded as fully depreciated in subsequent years.

For example, office furniture is usually depreciated over 7 years under the normal rules found in the Internal Revenue Code and in the year of acquisition, the depreciation deduction is 14.29% of the full purchase price. Under the Bonus Depreciation rules, the depreciation deduction would be 100% of the full purchase price.

Bonus Depreciation extended through the Tax Act of 2017 will be phased out over the next several years. The allowance for bonus depreciation will be 100% for qualified assets placed in service in 2018 through 2022, 80% in 2023, 60% for 2024, 40% for 2025, and 20% for 2026.

Oversight in the Tax Cuts and Jobs Act has immediate implications for certain property otherwise defined as qualified improvement property

As described in the Joint Explanatory Statement provided in tandem with the release of the Tax Cuts and Jobs Act (the Act), Congress intended to provide a 15-year recovery period for qualified improvement property (QIP) placed in service after December 31, 2017. Due to an apparent oversight by the drafters of the legislation, however, Section 168(e)(3)(E), the provision generally describing the property to which a 15-year recovery period applies, was not amended to include QIP. This Tax Alert provides details on the implications associated with this oversight.

Depreciation of certain real property before the enactment of the Act

Under prior law, Section 1687(e) contained separate definitions for qualified leasehold improvement property, qualified restaurant property, and qualified retail improvement property, providing a 15-year recovery period for each type of property. Further, Section 168(k)(3) provided an additional definition for QIP. Specifically, QIP was any improvement to the interior of a building that was nonresidential real property if the improvement was placed in service after the date of the building was first placed in service. Further, QIP could be recovered under the general depreciation system over either 15 or 39 years, depending on whether such property also met the definition of qualified leasehold improvement property (and, thus, was treated as nonresidential real property).

In addition, prior law allowed taxpayers to claim additional depreciation (i.e. bonus depreciation) under Section 168(k) in the year in which qualified property was placed in service through 2019 (with an additional year to place the property in service for qualified property with a longer production period, as well as certain aircraft). Bonus depreciation generally equaled 50% of the cost of the property placed in service in 2017 and phased down to 40% in 2018 and 30% in 2019. Qualified property included tangible property with a recovery period of 20 years or less under the modified accelerated cost recovery system (MACRS), as well as QIP, provided the remaining requirements of Section 168(k)(2) were met.

Depreciation of certain real property under the Act

The Act eliminates the separate definitions of qualified leasehold improvement property, qualified restaurant property and qualified retail improvement property and now provides for a single definition for QIP under Section 168(e)(6). Although the definition of QIP is provided in Section 168(e)(6), QIP is not specifically included in Section 168(e)(3)(E) as having a 15-year recovery period.

The Act extends the bonus depreciation deduction through 2026. The Act allows taxpayers to claim 100% bonus depreciation with respect to qualified property acquired and placed in service after September 27, 2017, and before January 1, 2023, phasing down bonus depreciation to 80% for qualified property placed in service before January 1, 2024; 60% for qualified property placed in service before January 1, 2025; 40% for qualified property placed in service before January 1, 2026; and 20% for qualified property placed in service before January 1, 2027. The Act specifies that qualified property includes tangible property with a recovery period of 20 years or less under MACRS, provided the remaining requirements of Section 168(k)(2) are met. The Act removed the specific reference to QIP as being qualified property.

The modifications specific to the removal of the qualified leasehold improvement property, qualified restaurant property and qualified retail improvement property definitions apply to property placed in service after December 31, 2017, while the modifications specific to bonus depreciation apply to property acquired and placed in service after September 27, 2017, generally.

Implications

While it appears that Congress intended to provide a 15-year recovery period for QIP under the MACRS general depreciation system, the provisions set forth in the Act do not provide a 15-year recovery period for QIP at this time. As a result, taxpayers must immediately analyze the impact this has on their fixed asset portfolio. When determining the effect of the QIP oversight on a fixed asset portfolio, taxpayers should keep in mind that the existing definition of qualified leasehold improvement property, qualified retail improvement property and qualified restaurant property (all generally replaced by QIP under the Act) is in effect through December 31, 2017. The recovery period for property that meets the definition of qualified leasehold improvement property, qualified retail improvement property, and qualified restaurant property is 15 years to the extent it is acquired and placed in service by December 31, 2017.

Qualified leasehold improvement property and qualified retail improvement property is generally eligible for 50% bonus depreciation to the extent acquired and placed in service by September 27, 2017, and generally eligible for 100% bonus depreciation if acquired and placed in service from September 28, 2017, to December 31, 2017. Qualified restaurant property is generally eligible for 50% bonus depreciation provided that it also meets the definition of QIP. Due to differences in the effective date of certain provisions of Section 168 under the Act, QIP is effectively removed from the description of qualified property under the bonus depreciation provisions for assets acquired and placed in service from September 28, 2017, to December 31, 2017, so there can be no bonus-eligible qualified restaurant property during this period.

QIP placed in service on or after January 1, 2018, is recovered over 39 years and is not bonus eligible until such point as a technical correction to the Act is enacted.