The recently enacted Tax Cuts and Jobs Act (“TCJA”) is a sweeping tax package. Here’s an overview of the important changes that highlight the already beneficial Cost Segregation Study. Unless otherwise noted, the changes are effective for tax years beginning in 2018.
TCJA’s Bonus Depreciation Changes Make Cost Segregation Even More Beneficial:
- Under the new law, a 100% first-year deduction is allowed for qualified new and used property acquired and placed in service after September 27, 2017 (with no written binding contract for acquisition in effect on Sept. 27, 2017) and before 2023. Pre-Act law provided for a 50% allowance, to be phased down for property placed in service after 2017. Under the new law, the 100% allowance is phased down starting after 2023.
- September 27, 2017 becomes significant since it triggers different levels of bonus depreciation based on in-service dates and when qualified property improvements (QIP) were made. Unlike past years’ requirements that bonus depreciation be related to original use property, the final version applies to acquired property as well effective September 27, 2017!
Modification of Like-Kind Exchange Rules:
- In a like-kind exchange, a taxpayer doesn’t recognize gain or loss on an exchange of like-kind properties if both the relinquished property and the replacement property are held for productive use in a trade or business or for investment purposes. For exchanges completed after Dec. 31, 2017, the TCJA limits tax-free exchanges to exchanges of real property that is not held primarily for sale (real property limitation). Thus, exchanges of personal property and intangible property can’t qualify as tax-free like-kind exchanges.
- Although the real property limitation applies to exchanges completed after Dec. 31, 2017, transition rules provide relief for certain exchanges. Specifically, the real property limitation doesn’t apply to an exchange if the relinquished property is disposed before Jan. 1, 2018, or the replacement property is received by the taxpayer before Jan. 1, 2018. If the transition rules apply and all other requirements for a tax-free exchange are satisfied, an exchange of personal property or intangible property that is completed after Dec. 31, 2017 can qualify as a tax-free like-kind exchange.
Qualified Improvement Property:
- Under new law, for tax years beginning after 2017, provides that Qualified Improvement Property (QIP), in addition to being eligible for bonus depreciation and being newly eligible as section 179 property, is depreciable using a 15-year recovery period and the straight-line method (rather than 39-year period for non-residential buildings).
Definition of QIP:
QIP is any improvement to an interior portion of a building that is nonresidential real property placed in service after the building was placed in service. It does not include expenses related to the enlargement of the building, any elevator or escalator, or the internal structural framework.
Qualified Leasehold, Retail, and Restaurant Improvement Property:
- There are no longer separate requirements for Qualified Leasehold Improvement Property (QLIP) and Qualified Restaurant Property (QRP) and Qualified Retail Improvement Property (QRIP). These separate distinctions were eliminated as of December 31, 2017, leaving only Qualified Improvement Property (QIP).
Qualified Real Property:
- For tax years beginning after 2017, the definition of this property has been expanded for Section 179 purposes to include roofs, HVAC, fire protection and alarm/security systems. It can also be expensed under Section 179 subject to its parameters below.
- One of the more significant new law provisions cuts the corporate tax rate to a flat 21%. Before the new law, rates were graduated, starting at 15% for taxable income up to $50,000, with rates at 25% for income between 50,001 and $75,000, 34% for income between $75,001 and $10 million, and 35% for income above $10 million.
- Under new law for tax years beginning after 2017, the annual 179 expense threshold is set at $1,000,000 with a $2,500,000 phase out.
- Also, items (for example, non-affixed appliances) used in connection with residential buildings (but not the buildings or improvements to them) are section 179 property.
Real Property Depreciation:
- Apartment buildings and other residential rental buildings placed in service after 2017 generally continue to be depreciated over a 27.5 period, but should the alternative depreciation system (ADS) apply to a building either under an election or because the building is subject to one of the conditions (for example, tax-exempt financing) that make ADS mandatory, the ADS depreciation period is 30 years instead of the pre-TCJA 40 years.
- For tax years beginning after 2017, if a taxpayer in a real property trade or business “elects out” of the TCJA’s limits on business interest deductions, the taxpayer must depreciate all buildings and qualified improvement property under the ADS.
Other Changes Relating to Cost Recovery and Property Transactions:
TCJA makes the following additional changes with respect to cost recovery and property transactions:
- allows for expensing of certain costs of replanting citrus plants lost by reason of casualty;
- allows an electing real property trade or business to use the ADS recovery period in depreciating real and qualified improvement property;
- shortens the recovery period from 7 to 5 years for certain machinery or equipment used in a farming business;
- repeals the required use of the 150-percent declining balance method for depreciating property used in a farming business (i.e., for 3-, 5-, 7-, and 10-year property);
- excludes various types of self-created property from the definition of a “capital asset”, including: patents, inventions, models or designs (whether or not patented), and secret formula and processes;
- specifies situations in which a contribution to the capital of a corporation is includable in the gross income of a corporation (i.e., contributions by a customer or potential customer, and contributions by governmental entities and civic groups); and
- tweaks the carried interest rule to provide that a profits interest must be held for three years, rather than one year, in order to receive favorable long-term capital gain treatment.