Tax Law's Lack Of Clarity On Bonus Depreciation Could Have Major Implications For Real Estate
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The new tax reform law is expected to have several implications for real estate professionals, but some things are still unclear. The Tax Cuts and Jobs Act creates limitations for depreciation of qualified improvement property. Given the Sept. 27, 2017, effective date for bonus depreciation, these limitations could have an immediate impact on 2017 tax returns filed in 2018.
While building improvements are generally depreciable over 39 years, certain types of qualified real property, including qualified leasehold improvements, qualified restaurant property and retail improvement property, have historically been eligible for a 15-year cost recovery period and Section 179 expensing. Each of these three categories has specific criteria, and qualified restaurant property has the fewest limitations.
TCJA consolidated all three categories of qualified real property into one: qualified improvement property. Congress likely intended to make QIP eligible for a 15-year Modified Accelerated Cost Recovery System class life and 20-year Alternative Depreciation System class life, but its failure to include a provision linking QIP to these class lives makes its depreciation uncertain.
Bonus depreciation allows faster depreciation of assets with class lives of 20 years or less and enables businesses to deduct an increased percentage of the cost basis of qualifying property placed in service during that tax year. Before TCJA, the bonus percentage was set to drop from 50% to 40% in 2018, 30% in 2019 and expire in 2020.
QIP has been eligible for bonus depreciation in the past. The original definition provided that the improvement must be specific to the interior of a nonresidential building and placed in service after the date the associated building was first placed in service.
Under TCJA, the enhanced bonus depreciation percentage is 100% for property with class lives of 20 years or less that are placed in service after Sept. 27, 2017, and before Jan. 1, 2023. The enhanced bonus depreciation under TCJA phases out in 2023 and expires in 2027. The available bonus depreciation during that time is 80% in 2023, 60% in 2024, 40% in 2025 and 20% in 2026.
While the enhanced bonus depreciation would benefit business planning expansion, improvement projects and new purchases, its current application to QIP is unclear.
This uncertainty impacts real property trade or businesses (RPTB) that have average annual gross receipts in excess of $25M over the prior three years. This RPTB category includes real property development, redevelopment, construction, reconstruction, acquisition, conversion, rental, operation, management, leasing or brokerage trade or business. For RPTBs, business interest deductions after Dec. 31, 2017, will be limited to the sum of business interest income plus 30% of adjusted taxable income. An RPTB can elect out of the business interest limitation rules and deduct all of its business interest expenses, but must depreciate any residential rental property, nonresidential rental property and QIP using the longer ADS class lives.
Commentators anticipate that Congress will pass a technical corrections bill that will be retroactive to the effective dates under TCJA, but RPTBs cannot count on 100% bonus depreciation for QIP placed into service in 2018 if they elect out of the business interest limitation rules. Professionals can work with a tax adviser to analyze how a 39-year depreciation schedule would affect their taxes moving forward.
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