Tax Reform: Revised Tax Depreciation Rules

The Tax Cuts and Jobs Act passed Congress on December 20, 2017 and was signed into law by the President on December 22, 2017 (the enactment date) and is generally effective for tax years beginning after 2017.  This is the sixth in a series of articles reviewing some of the more important changes.  This post deals with the new rules for depreciation.

Bonus Depreciation

The percentage deduction is increased from 40% (the scheduled reduction for 2018) to 100% for business personal property purchased and placed in service after September 27, 2017 and before January 1, 2023.  After 2022 the percentage is reduced to 80% in 2023, 60% in 2024, 40% in 2025, 20% in 2026, and 0% after 2026.  An asset is considered placed in service when it is ready, available, and capable of performing its intended function.  Other changes include:

·      The new or “original use” requirement is dropped in favor of the taxpayer’s “first use” of the property not acquired from a related party (thus “used” property now qualifies for bonus depreciation).

·      Taxpayers may elect 50% instead of 100% for the first tax year ending after September 27, 2017.

·      Bonus depreciation is extended to film, TV, and theatrical performance assets.

·      Qualified improvement property (QIP, improvements to the interior of nonresidential real property that are placed in service after the date the building is placed in service) eligible for 15-year depreciation qualifies for bonus depreciation.  It appears that a technical correction is necessary to ensure that QIP placed in service after 2017 is eligible for 15-year instead of 39-year depreciation and therefore eligible for bonus depreciation.  The statute appears clear that QIP placed in service after September 27, 2017 and before 2018 is eligible for 15-year and bonus depreciation.  QIP does not include improvements attributable to the enlargement of a building, or any elevator or escalator, or internal structural framework of a building.

·      Bonus depreciation is denied to taxpayers who are exempt from the 30% interest expense limitation (other than by reason of the $25 million average gross receipts exemption):

o   Floor plan financing businesses

o   Real property businesses electing out of the interest limitation

o   Farm businesses electing out of the interest limitation

Section 179 Expensing

The current $520,000 §179 expense limitation for 2018 is increased to $1,000,000.  The dollar for dollar phase out of the deduction purchases of qualified property exceed $2,070,000 is increased to $2,500,000.  Other changes include:

·      Eligible property is expanded to include nonresidential property improvements for roofs, HVAC, fire protection and alarm systems, and security systems.

·      Eligible property is expanded to include qualified improvement property (QIP) eligible for 15-year depreciation.

·      Eligible property is expanded to include tangible personal property used predominantly to furnish lodging (e.g., beds, furniture, appliances).

·      The current $25,000 limit for heavy SUVs, certain trucks, and certain passenger vans remains but it is now indexed for inflation after 2018.

Choosing Between Bonus and §179

The following is a list of factors to consider when choosing between claiming bonus or §179 depreciation:

·      If 2017 will be a net operating loss, choose bonus depreciation to drive the loss even higher because NOLs generated in tax years beginning before 2018 can offset 100% of taxable income in future years instead of only 80%.  Alternatively, NOLs generated in tax years ending before 2018 can be carried back.

·      §179 is limited to taxable income, it can’t create or increase an NOL whereas bonus depreciation can both create and increase an NOL.

·      §179 is subject to phase-out if total purchases exceed $2,500,000 which can result in permanent loss if a taxpayer owns an interest in more than one pass-through entity each claiming §179.  Bonus depreciation is not subject to phase-out based on purchases.

·      §179 can only be used when business use exceeds 50% whereas, except for passenger automobiles, bonus depreciation can be used for any percentage of business use.

·      §179 requires recapture income if business use falls to 50% or less whereas there is no recapture for bonus depreciation.

·      §179 cannot be deducted by trusts or estates whereas bonus depreciation is permitted.

·      §179 may be claimed or revoked on an amended return unlike for bonus depreciation.

·      §179 allows individual assets to be selected, it isn’t an all or nothing choice for an asset class like it is for electing out of bonus depreciation.

·      §179 is permitted, and bonus depreciation is not permitted, for taxpayers required to use the alternative depreciation system (tax-exempt use property, tax-exempt financed property, or property used outside of the U.S.)

·      179 is permitted, and bonus depreciation is not permitted, for taxpayers electing out of the 30% limitation on business interest or using floor-plan financing.

·      While Utah follows Federal law, some states may not permit bonus depreciation while allowing some amount of §179 expensing.

·      Remember the annual election to expense asset purchases of up to $2,500 (or $5,000 for taxpayers with an “applicable financial statement”) per unit of property under a taxpayer’s capitalization policy.  Such expensing is preferred over bonus and §179 because the asset is never recorded on the depreciation schedule.

Increased “Luxury” Auto Depreciation Limits

Yearly auto depreciation limits are increased for property placed in service after 2017.  For passenger automobiles purchased after September 27, 2017 and placed in service after 2017, first year bonus depreciation of $8,000 is allowed and is added to the 1st Tax Year amount below.  However, if the purchase was made prior to September 28, 2017 and the automobile placed in service after 2017, first year bonus depreciation is only $6,400 according to Rev. Proc. 2018-25.

Year	Current Law	New Law
1st Tax Year	$3,160	$10,000
2nd	$5,100	$16,000
3rd	$3,050	$  9,600
4th & thereafter	$1,875	$  5,760

Farm Property

The depreciation period for “new” or “original use” machinery and equipment placed in service after 2017 and used in a farming business is shortened from 7 to 5 years.  However, such property does not include grain bins, cotton ginning assets, fences, or other land improvements.  “Used” machinery and equipment therefore continue to have a 7-year depreciation period.  In addition, the 200% declining balance method applies instead of the 150% method for farm property (new or used) placed in service after 2017.  However, 15-year and 20-year property continue to use the 150% method.

Farming businesses that elect out of the 30% interest deduction limitation must use the alternative depreciation system (ADS) to depreciate any property with a recovery period of 10 years or more, such as single purpose agricultural or horticultural structures, trees or vines bearing fruit or nuts, farm buildings and certain land improvements.