Many people interpret the term déjà vu as referring to an occurrence of the exact same events multiple times and to many this is exactly how the expensing and depreciation provisions of the latest round in extenders legislation, the Protecting Americans from Tax Hikes (PATH) Act, may appear at first glance.
However, the Merriam-Webster Dictionary provides the primary definition of déjà vu as being “the feeling that you already experienced something that is actually happening for the first time.” A closer look at the PATH Act’s seemingly standard extensions of 179 expensing and bonus depreciation reveals that this may in fact be a true moment of déjà vu with new deduction opportunities for real property.
Expansion of Bonus
The PATH Act once again extended the availability of bonus depreciation allowing 50 percent bonus on assets placed in service from 2015 through 2017 and then beginning to phase-out bonus depreciation through reduced percentages of 40 percent and 30 percent for property placed in service in 2018 and 2019 respectively.
However, the revisions made to 168(k) by the PATH Act do more than just extend placed in service dates for the availability of bonus. Previously, only real property that met the definition of a “qualified leasehold improvement” (QLHI) was considered bonus eligible property. Under the PATH Act real property placed in service after December 31, 2015 that is “qualified improvement property” (QIP) is considered eligible for bonus depreciation.
QIP is a new term created by the PATH Act and is specifically defined in the revised 168(k)(3) as being any improvement to an interior portion of a building which is non-residential real property that is placed in service after the date such building was first placed in service and is not attributable to the enlargement of the building, any elevator or escalator or the internal structural framework of the building.
While the definitions of QLHI and QIP are in many ways very similar there are a few notable and taxpayer friendly differences.
First there is no requirement that QIP be made under or pursuant to a lease. This means that otherwise eligible interior improvements made by the owners of an owner occupied commercial building may now qualify for bonus depreciation. Additionally, since there is no lease requirement and therefore no related party lease prohibitions otherwise eligible improvements made in the context of related party leases will potentially qualify for bonus depreciation.
The second notable difference is that there is no longer a required three year lag period between when the building is originally placed in service and when the improvement is placed in service. Under the new rule the improvement simply has to be placed in service after the date the building is first placed in service.
Lastly, under the old QLHI “subject to lease” rules the improvements had to be made to a portion of the building to be occupied exclusively by the lessee or sublessee. This requirement effectively excluded improvements to common areas from qualifying for bonus depreciation. Under the new QIP definition these common area improvements would be bonus eligible property provided that all other requirements are met.
Given the new stand-alone definition of eligible property for purposes of bonus depreciation the classification of an improvement as either QLHI, retail improvement property or restaurant improvement property may seem completely irrelevant. However this is most definitely not the case.
While property meeting the QIP definition will be eligible for bonus depreciation it will not be eligible for depreciation over a 15 year life unless it also meets the definition of either QLHI, qualified retail property or qualified restaurant property. The PATH Act extended and made permanent the MACRS 15 year life for QLHI, qualified retail property and qualified restaurant property but it did not extend the 15 year life to include QIP. As a result there may be real property improvements which now qualify for bonus but are required to be depreciated over 39 years with respect to the remaining basis.
Additionally, qualified restaurant property differs from QIP in that it encompasses more than just interior improvements to a building and does not prohibit certain improvements such as enlargements or enhancements to the structural framework from being included. As a result correct classification as qualified restaurant property will be key for restaurant building owners looking to obtain significantly accelerated depreciation deductions through use of the shorter 15 year depreciation life for buildings and real property improvements that do not qualify for bonus.
Finally, availability of the newly enhanced section 179 real property expensing provision is directly tied to a property’s classification as either QLHI, qualified retail property or qualified restaurant property.
Expansion of Section 179 Expensing for Real Property
The PATH Act once again extended and made permanent the $500,000 dollar limitation for expensing of section 179 eligible property and the $2,000,000 beginning-of-phaseout threshold amount for excess section 179 property. *
The PATH Act also extended and made permanent the election to treat qualified real property as section 179 property. Beyond this it expanded the taxpayer’s ability to claim section 179 deductions for qualified real property by removing the separate real property section 179 dollar limitation beginning with the 2016 tax year. As a result taxpayers may elect to use their entire section 179 dollar limitation to expense qualified real property expenditures.
Qualified real property (QRP) for purposes of section 179 does not reference QIP. Instead it continues to be defined as property meeting the QLHI, qualified retail or qualified restaurant property definitions for inclusion in the 15 year MACRS class. Additionally, treatment of QRP expenditures as section 179 property is not mandatory. QRP expenditures are only treated as section 179 property if the taxpayer elects to include them for the tax year.
This election is similar to an on/off switch which may toggled on or off by the taxpayer for any particular tax year. The ability to toggle this election on or off is critically important to a taxpayer’s ability to maximize their section 179 deductions. In years the taxpayer elects to include QRP as section 179 property all QRP expenditures must also be treated as 179 property for purposes of determining the investment in section 179 property total for phase-out purposes. In contrast while a taxpayer may not expense any QRP under section 179 in years it decides not to make the election the taxpayer will likewise not include any QRP as section 179 property for purposes of calculating any phase-out of the dollar limitation.
The determination of whether the election is beneficial will depend on the amount of QRP and tangible personal property placed in service during the tax year.
As an example consider a taxpayer who has incurred $500,000 of QRP expenditures and also purchased $500,000 of tangible personal property. In this instance electing to treat QRP expenditures as section 179 property will be of benefit to the taxpayer allowing him to expense the entire amount of longer lived 15 year QRP and recognize regular MACRS depreciation on the shorter lived tangible personal property.
Now let’s compare this with an example in which the taxpayer’s QRP expenditures are $1,500,000 and tangible property purchased during the year is also $1,500,000. In this case the taxpayer will benefit from not making the election. The $500,000 section 179 dollar limitation is required to be phased-out dollar for dollar to the extent that the investment in section 179 property exceeds the $2,000,000 threshold amount. By electing to include the QRP expenditures the taxpayer would have an investment in total section 179 property of $3,000,000 which exceeds the $2,500,000 amount at which the entire $500,000 section 179 dollar limitation is completely phased out. As a result the taxpayer would not be able to claim any section 179 deductions with respect to any type of property. However, by toggling the switch to off and forgoing the election to include QRP the taxpayer may take $500,000 of section 179 deduction for the tangible personal property. Under this scenario the investment in section 179 property would only include tangible personal property and would be $1,500,000 which is less than the $2,000,000 phase-out threshold leaving the entire $500,000 dollar limit intact.
When viewed from this perspective the extension of bonus but not section 179 to QIP may prove to be an overall windfall to certain taxpayers allowing them some immediate expensing of 39 year costs via bonus depreciation while at the same time excluding them from the investment in section 179 property and potentially allowing for higher real property expense deductions under section 179 for expenditures that also qualify as QLHI, qualified retail or qualified restaurant property.
Overall, while the PATH Act clearly does provides increased accelerated deductions for real property, determining how to apply new definitions, property classifications and their resulting interactions may prove to be unclear. Add to this the complexity of interactions with other regulations, (such as the tangible property regulations) and revenue procedures (such as the new remodel and refresh safe harbor for retailers and restaurants) and spotting the clear course to an optimal tax strategy may be quite a daunting task. However, for those who are successful there is much to be gained.
For more information on developing a successful real and tangible property tax strategy for your business contact your Dixon Hughes Goodman tax advisor or one of the following tax professionals:
Heather Alley, Partner
ph: 828.236.5848 email: firstname.lastname@example.org
Adam Neporadny, Senior Manager | DHG Dealerships
ph: 205.212.5317 email: email@example.com
* Both amounts are subject to indexing for inflation in tax years beginning after 2015