Since the passage of the Tax Cuts & Jobs Act on December 22, we have seen a barrage of articles attempting to summarize and explain the effects this tax reform package will have on individuals and businesses. The purpose of this article is to highlight a few of the more impactful aspects of the package for taxpayers owning 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. However, under the new law, a real property trade of business will have to utilize the Alternative Depreciation System (ADS) if it elects out of the limitation on interest deductions (more on that later). Using the ADS requires 40-year, 30-year, and 20-year depreciable lives, as opposed to 39, 27.5 and 15 year lives for non-residential real property, residential rental property and qualified improvement property, respectively. Bonus depreciation is increased from the previous 50% to 100% for qualified assets acquired after September 27, 2017 through 2022. The bonus rate decreases by 20% each year after 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.
Beginning in 2018, there will be no differentiation among qualified leasehold improvements, qualified retail improvements, and qualified restaurant property. These are all replaced with a 15-year recovery period for Qualified Improvement Property. The good news is that these items will be subject to the 100% bonus depreciation rules. The bad news, in the case of the former Qualified Restaurant Property, is that the exterior structure of a restaurant building will no longer qualify for such treatment and must generally be depreciated over 39 years.
The depreciation changes present some enormous planning opportunities which we will cover in a later installment.
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 is also now eligible.
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’s 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 corporate alternative minimum tax is being fully repealed as of 2018. The individual AMT remains, though with higher phase-out thresholds through 2025, resulting in fewer individuals being subject to AMT.
The Tax Cuts and 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.