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Tax Cut and Jobs Act: A Close Look at Depreciation Treatment

  • Published on Dec 14, 2018
  • by David McGuire

Our Tax Expo speaker David McGuire previews his presentation in the following article.  

To hear more from him and other great speakers, register for the 29th Annual Tax Expo January 7-8th at the Sugar Land Marriott Town Square here.

In late 2017, the Tax Cuts and Jobs Act (TCJA) brought sweeping changes to the U.S. Tax Code. This included changes to personal deductions and tax rate adjustments as well as other far-reaching revisions. Some of the biggest areas affected under the TCJA relate to depreciation treatment. These areas include bonus depreciation, requirements to utilize the Alternative Depreciation System  and 1031 exchanges. 

Due to the magnitude of these changes, they will often have a much larger impact on an affected taxpayer’s return than the adjustments to tax rates. This means that for many taxpayers, depreciation should be a major focus of their annual tax planning.

Let’s look closer at these three areas:

Bonus Depreciation

One of the biggest areas of change regards 100% bonus depreciation for a five-year period. Under the new rules, companies that install eligible property can take advantage of 100% bonus depreciation. Assets acquired and placed in service, subject to binding contract restrictions, between September 27, 2017, and December 31, 2022, are eligible for this accelerated treatment. After 2022, this bonus depreciation percentage will start phasing down.

In addition to increasing the amount of bonus depreciation, the TCJA also increases the types of property that are eligible. In the past, bonus depreciation was restricted to new property that passed the “first use” test, which stipulated the taxpayer had to be the first one to utilize the property to qualify for bonus depreciation. That restriction was removed under the new bill, and now used property is eligible for bonus treatment, with some restrictions for related party transactions. 

This effectively means that a taxpayer can purchase a used piece of equipment and take bonus depreciation on it, effectively expensing the entire purchase price in one year. The bonus depreciation guidelines contain some wrinkles, however. The biggest one is that bonus guidelines currently exclude Qualified Improvement Property (QIP).  Prior to the TCJA, bonus depreciation included certain types of “qualified real property,” such as Qualified Leasehold Improvements and Qualified Improvement Property. To simplify the system, the TCJA combined all qualified property into one asset class called Qualified Improvement Property, or QIP. In creating the law, the intention was to provide QIP a 15-year life and make it bonus eligible. Unfortunately, in the drafting process, the 15-year life was mistakenly left out. Without a technical correction, QIP is now considered 39-year property and is not eligible for bonus treatment. It is widely expected that a technical correction bill will pass to fix this error.

Alternative Depreciation System

Under the TCJA, new restrictions were placed on certain types of property requiring the use of the Alternative Depreciation System, or ADS.  These restrictions include requiring ADS for real property when a taxpayer elects out of the 30% interest expense limits, or on all property if a taxpayer deducts floorplan interest. This will require advanced tax planning to determine whether the bonus depreciation is more valuable than the interest deductions.  

A review is especially critical if QIP receives bonus eligibility in a technical corrections bill. In this case, QIP would be considered real property. Under the TCJA, companies with gross receipts of $25 million or more are subject to a 30% limitation on interest deductibility, unless they elect to be treated as a real estate entity. However, that election requires that all real property be taken utilizing ADS. That means that taxpayers electing out of the 30% interest limitations would be restricted from taking bonus depreciation on their QIP, provided the correction is made.  This could add up to significant money for real estate companies that have performed major tenant improvements over the year.

1031 Exchanges

One of the biggest impacts of the TCJA is on 1031 exchanges. In the past, 1031 exchanges could be completed on real property and certain types of personal property transactions. Under the new law, 1031 exchanges can only be completed on “real property” transactions. Furthermore, the IRS has previously confirmed in Legal Memorandum 201238027 that real property for 1031 exchanges follows the federal definition for 1250 property. Taxpayers need to do some tax planning to determine if they want to recognize personal property that might lead to some recapture on a sale involving a 1031 exchange.  In most cases it will still make sense, but it requires a discussion with a trained professional.

In a nutshell, the rules surrounding depreciation became more lucrative to the taxpayer under the TCJA, but also more complicated. It is more important than ever that taxpayers and tax preparers work with qualified individuals to navigate the new rules. 

For additional information on depreciation treatment, attend the 2019 Tax Expo. Register here.

This is an article from Houston CPA Society's Online Magazine called the Forum. Read the full magazine here. 

About the author:

David McGuire is a leading expert on cost segregation, fixed assets and depreciation law and a co-founder of McGuire Sponsel. He has reviewed real estate portfolios ranging in size from six-figure acquisition costs to billions of dollars in value and has provided cost segregation services for companies in a wide variety of industries. Visit McGuire Sponsel website here.