Since the passage of the Tax Cuts & Jobs Act on December 22, 2017, we’ve had some time to digest this new law and analyze the effects this tax reform package will have on individuals and businesses. As we approach the upcoming tax filing season, it’s a good time to take another look at some of the more impactful aspects of tax reform for owners of commercial real estate. Keep in mind that this analysis is general in nature, and the application of these issues to any specific taxpayer will require consultation with a professional tax advisor.
Residential rental property will generally continue to be depreciated over 27.5 years, while non-residential real property will continue to be depreciated over 39 years. Bonus depreciation is increased from the previous 50% to 100% for qualified assets acquired after September 27, 2017 through 2022. Generally speaking, assets with a recovery period of fewer than 20 years will be subject to 100% bonus depreciation under the new law. Also, the previous original use requirement for bonus depreciation is removed for purposes of this bonus depreciation provision. This is great news for buyers of existing property. Keep in mind that the law has a “written binding contract” provision, which means that if you had a written binding contract in place as of September 27, 2017, you will be subject to the pre-TCJA depreciation provisions. As a result, most newly-built assets placed in-service in 2018 will be subject to the old rules.
Congress originally intended to define “qualified improvement property” as certain improvements to the interior of a building that is eligible for a depreciable life of 15 years (as opposed to 39 years) and eligible for 100% bonus depreciation. However, in their haste to pass the legislation, the authors of the final law failed to specify the special treatment of qualified improvement property. Lawmakers would need to correct this oversight with a technical corrections bill. Until then, the IRS has indicated that it will administer the law as written – in other words, there will be no special treatment for qualified improvement property and it must be depreciated over 39 years. However, read the next paragraph to learn how a cost segregation study could help to identify shorter-lived assets within qualified improvement property.
The depreciation changes present some enormous planning opportunities. Cost segregation, which has always presented a great opportunity to accelerate depreciation deductions, can be even more beneficial under the new law. For building acquisitions (or improvements to existing properties) under TCJA, any assets that can be classified as shorter-lived property (instead of the general 39 years) will be subject to 100% bonus depreciation. For example, assume a $2,000,000 building, with 10% of the cost reclassified to a shorter depreciable life. That $200,000 would have produced about $5,100 annually in depreciation deductions without cost segregation. The same $200,000 will be written off entirely in the year of acquisition under the new law, if properly segregated, classified, and expensed as a result of a cost segregation study. That’s a difference of almost $195,000 in deductible expense the first year, producing over $48,000 in reduced tax burden, assuming a 25% effective tax rate (varies depending on facts).
Section 179 Expensing Expansion
Expense limitations under Section 179 will double in 2018 from $500,000 to $1 million, while the phase-out limitation will be increased from $2 million to $2.5 million. Also, property eligible for section 179 has been expanded to include roofs, HVAC, fire protection and alarm systems, and security systems. These items were previously ineligible for Section 179, as was tangible personal property used in connection with furnishing lodging, which are also now eligible.
Other Relevant Items
For tax years beginning after December 31, 2017, every business is generally subject to a disallowance of the deduction for net interest expense in excess of 30% of the business’ adjusted taxable income. Adjusted taxable income is computed without regard to deductions allowable for depreciation, amortization, or depletion. In other words, it may be complicated to determine the extent to which interest may be limited, so consult your tax advisor.
Deferred gains on the exchange of real property continue to be allowed through a 1031 exchange, but such tax-deferred exchanges are no longer allowed for tangible personal property acquired after December 31, 2017. As has always been the case, exchanges require extensive planning and thought to mitigate negative tax consequences.
The Tax Cuts & Jobs Act is the most extensive tax legislation we’ve seen in several decades, so this is not to be considered an all-inclusive list of relevant provisions. There are many important issues to consider moving forward when it comes to tax planning for real estate. If you are a real estate investor or have real estate in your operating business, you may want to discuss these issues with your tax advisor over the coming months. In the meantime, be on the lookout for more information and helpful articles about the TCJA.
John R. McCallum, CPA
John R. McCallum is a member with GranthamPoole PLLC and a recognized leader in the field of cost segregation and various real estate taxation matters. He has also written, taught, and spoken on many topics in the area over the years. Please contact John at email@example.com, www.linkedin.com/in/john-mccallum, or 601-499-2400. CPA License # 5323
The above does not represent tax advice. Each situation is fact-dependent, and you should seek the advice of a competent advisor. GranthamPoole PLLC is a provider of tax, accounting, advisory and strategic services, partnering with clients across a broad spectrum of industries and sizes.