The Tax Cuts and Jobs Act (“TCJA”) made significant changes to the way the cost of assets used in a trade or business are deducted under Internal Revenue Code Section 179 and the Bonus Depreciation rules.
Section 179 Expensing
Section 179 allows a business to expense the full cost of qualifying assets. Previously, businesses could immediately expense up to $500,000 of qualifying Section 179 depreciable business assets placed in service in each tax year. This deduction was limited by a dollar-for-dollar phase-out if qualifying business assets placed in service exceeded $2 million. Additionally, the deduction was limited to taxable income for the year, with the ability to carryover any disallowed deduction to the next year.
In an effort to provide relief for small businesses, the Section 179 deduction under the TCJA is increased to $1 million and the phase-out limitation is increased to $2.5 million for tax year 2018.These thresholds will be indexed for inflation in subsequent tax years.
For property placed in service in tax years beginning after December 31, 2017, the TCJA also eliminates the separate definitions of qualified leasehold improvement property, qualified restaurant property and qualified retail improvement property, instead providing an expanded definition of qualified real property under Section 179 for all qualified improvement property, and certain improvements made to nonresidential real property. The new definition encompasses previously disallowed property such as roofs, heating, ventilation and air-conditioning property; fire protection and alarm systems; and security systems.
Under the TCJA, the additional first year bonus depreciation has been extended through December 31, 2026. Previously, taxpayers were able to deduct 50% of the adjusted basis of qualified original use property.
One of the largest incentives related to cost recovery changes the first year bonus depreciation to now be 100% for qualified property that is both acquired and placed in service after September 27, 2017.
While similar to Section 179, bonus depreciation does not come with phase-out or taxable income limitations. The 100% first year bonus depreciation is allowed through December 31, 2022 and then sunsets through tax year 2026 at a reduced rate of 20% each year.
Another significant change is the application of bonus depreciation to used property. Before, bonus depreciation was allowed only for original use property commencing with the taxpayer. Under the TCJA, this was modified to include used property as long as the taxpayer had not utilized it before acquisition.
Cost segregation studies can now be done for used property to separate real property assets from shorter life personal property assets. Bonus depreciation can then be employed for the used personal property, a change that can substantially benefit taxpayers.
Taxpayers may still elect 50% first year bonus depreciation rather than 100% first year bonus depreciation for property placed in service after September 27, 2017. Taxpayers in a loss position who may not benefit from immediate expensing may elect to slow down or opt out of bonus depreciation completely when considering tax planning.
Bonus depreciation will continue to be disallowed when depreciating assets under the Alternative Depreciation System (“ADS”). Thus, careful consideration will need to be given for any real estate businesses electing out of the new interest expense limitation rules under Section 163(j).
Although, when electing out of the Section 163(j) limitation, a taxpayer may use ADS for only the real property, as required, and choose to depreciate personal property under the General Depreciation System, thus remaining eligible for the 100% first year bonus depreciation.
If the taxpayer is a pass-through entity, such as a partnership, it will also need to consider the impact of bonus depreciation on the new 20% pass through deduction enacted by the TCJA. In some instances, a taxpayer may not want to elect bonus depreciation in order to obtain a higher 20% pass-through deduction.
There are many tax planning opportunities available under the new rules of the TCJA with regards to Section 179 expensing and first year bonus depreciation. As new guidance is issued, taxpayers should remain alert as to possible tax planning considerations.
Please contact your Mazars USA LLP professional for additional information.