The Tax Cuts and Jobs Act of 2017 signed by President Trump in late December came with a lot of goodies for businesses and their owners. Graduated corporate tax rates were replaced with a flat 21 percent rate and the Alternative Minimum Tax for corporations disappeared. Big changes for businesses and owners of rental properties came in the area of depreciation, which I am going to look at in this article.
Bonus depreciation is back, for now
Through 2022, and retroactive to Sept. 27, 2017, your clients can take 100 percent bonus depreciation on eligible property. But, in 2023, the percentage will drop by 20 percent a year, until it’s all gone in 2027.
To be eligible, property must have a depreciable life of less than 20 years, and this must be the first use of the property by the owner. One big change: for the first time, used property will be eligible for bonus depreciation as long as it’s still being used for the first time by that owner.
The advantage of bonus depreciation over Section 179 is that it can be used to create a loss. Section 179 deductions are disallowed to the extent of any loss they cause. Another advantage of bonus depreciation over Section 179 is that there are no limits to the amount of the deduction, except for automobiles, which I’ll look at below.
Nonresidential improvement property collapsed into one category
Qualified improvement property, a category that came out of the 2015 PATH Act, now replaces the prior categories of qualified leasehold improvements, qualified retail improvement property and qualified restaurant property.
These types of property were subject to restrictive qualifications. For example, qualified leasehold improvements had to be made pursuant to a lease between non-related parties. Now, the only qualification is that the improvements be made to the interior of a non-residential building and put in service after the building is first placed in service. Certain improvements, such as elevators, escalators, enlargement of the building or any internal structural components, are still specifically excluded.
I should note that it seems to be the intent of the law to give favorable 15-year life to qualified improvement property, which makes it eligible for bonus depreciation. But, as Tony Nitti points out, there’s no clear mention of the life in the modified statutes. So, qualified improvement property could still be 39-year property as it is under the old law. Hopefully, this will be fixed in a technical update.
Section 179 expensing expanded
Our beloved Section 179 was expanded in dollar limits and the definition of eligible property. Under the old law, business owners were allowed to immediately expense up to $500,000 worth of certain property acquired during the year. This limit was decreased dollar for dollar if a company acquired over $2 million worth of property.
Under the new law, a business can immediately expense up to $1 million worth of property, phasing out at $2.5 million in purchases. These amounts are indexed for inflation, and these increased limits are permanent.
The definition of eligible property has expanded, notably for rental properties. Previously, property “used predominantly to furnish lodging or in connection with furnishing lodging,” i.e., residential rental property, was excluded from Section 179. Now, however, this same property is eligible for Section 179 treatment.
This means the owners of residential rentals can now take Section 179 on the carpeting, appliances and hot water heaters that they regularly replace. However, Section 179 can’t be used to create a loss, so this expanded provision may not be as useful as it sounds.
For non-residential rentals, “qualified improvement property” is now eligible for section 179, as are improvements such as roofs, HVAC systems, fire protection and fire alarms, and security systems.
This means that the owner of a commercial rental property can choose between bonus depreciation and Section 179 treatment for the improvements made to the interior of the building, and write off many items that were previously disallowed.
Limits for luxury autos expanded
First-year depreciation for cars increased to $10,000, plus allowable bonus depreciation of $8,000, for a total of $18,000. Under the old law, the maximum including bonus was $11,160. For SUVs and trucks over 6,000 pounds, the Section 179 limit of $25,000 remains intact, but they are still eligible for 100 percent bonus depreciation, making the Section 179 limit moot.
These sweeping changes to depreciation will be a great addition to your toolbox of tax-saving strategies for your clients.