Tax Reform Update: Tax Savings with Depreciation

The Tax Cuts and Jobs Act (TCJA) greatly changed the bonus and Section 179 expense depreciation rules for businesses starting in 2018.  These changes allow businesses to take advantage of even greater deductions and provide a valuable business planning tool.  Any business, big or small, needs to be aware of these rules and changes to take advantage of the new deductions.

Bonus Depreciation

Historically, bonus depreciation had provided taxpayers the ability to immediately deduct 50% of the cost of qualifying fixed assets.  Previously, qualified fixed asset property included only brand new property. Used property was not eligible for the 50% bonus deduction.

Under the new TCJA rules, qualifying property has been expanded to include used assets.  Furthermore, bonus depreciation was increased from 50% to 100%, meaning fixed asset purchases can now qualify to be immediately written off in their entirety.  These new bonus rules are effective for any asset placed in service after September 28, 2017, unless there was a written binding contract to purchase the assets before  that date.

A significant benefit to taking bonus depreciation is that there is no maximum or phase-out limitation and no taxable income limitation to the deduction (it can be used to create losses).  This opens the door to significant tax deductions. The 100% bonus depreciation will be in place until 2022. After 2022, it will be phased down 20% per year and fully phased out by 2027.  To elect out of bonus depreciation, an election must be made by fixed asset class (i.e., all 5-year property), not by specific assets.

Section 179 Expense Election

The Section 179 expense election allowed taxpayers to expense qualifying assets immediately but was limited to $510,000 and reduced dollar for dollar as total assets placed in service exceeded $2,030,000.  This deduction is limited to taxable income.

Under the new TCJA rules, the Section 179 expense election was made permanent and was increased to $1 million, with the phase-out beginning at $2.5 million of qualifying assets placed into service.  Unlike bonus depreciation, Section 179 is still limited to taxable income and cannot be used to create losses.  The taxpayer can select specific assets to take Section 179.

Qualified Real Property

There have also been major revisions for deductions for qualified real property.  Through September 27, 2017, the tax law allowed deductions for qualified leasehold improvements, qualified retail improvement property, and qualified restaurant property that would otherwise be depreciated over 39 years, to use an accelerated 15-year life and qualified for bonus depreciation and Section 179.  Qualified leasehold improvement property was an improvement that was subject to a lease (not a related party), placed in service three years or more after the building was placed into service and non-structural to the building.

In 2016, a fourth type of property was introduced, titled “Qualified Improvement Property (QIP).”  This was different than the categories mentioned earlier in that it was not subject to the 3-year rule and not subject to a lease.  This type of property used a 39-year life but was eligible for bonus depreciation.

Starting after September 27, 2017, the TCJA rules eliminated the three subclasses of qualified property, and only QIP remains.  The definition of QIP was also broadened to include roofs, HVAC systems, fire and protection alarms, and security systems.

Under the new rules, QIP is still subject to the 39-year life and Section 179 expense can be taken, but not bonus depreciation.  There is a strong likelihood that the QIP life will be revised to 15 years and eligible for bonus depreciation, if a technical correction is passed.

Conclusion

It is important to know the rules as you start planning for the 2018 tax year.  There will be significant tax savings if you navigate through the new rules correctly.  Please contact your Clark Nuber professional or Rene Schaefer to understand these new tax provisions and determine how it may affect your business.

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