Tax Reform – Expensing and Depreciation
The Tax Cuts and Jobs Act recently signed into law by the President includes multiple provisions increasing depreciation limits which will apply to tax years beginning with the 2018 tax year or sooner for certain provisions. The following provisions are included in the bill:
- Immediate expensing (also referred to as bonus depreciation)
- Enhanced Section 179 depreciation
- Shorter recovery periods for farm/ranch equipment
- Increased luxury auto depreciation limits
- Elimination of separate categories for qualified real estate improvements
Immediate Expensing – 100% immediate expensing (bonus depreciation) is available for certain business expenses including machinery and equipment and qualified improvement property acquired and placed in service after September 27, 2017. The provision applies to both new and used property. As such, this provision heightens the importance of cost segregation studies. Costs identified as tangible personal property and land improvements are eligible for immediate expensing whether the property is new construction or acquired property. The 100% expensing is available through 2022, after which it begins phasing out by 20% per year. For example, immediate expensing is limited to 80% in 2023, 60% in 2024 and so forth until it is fully phased out in 2027.
Enhanced Section 179 Depreciation – The popular Section 179 deduction has been increased from $500,000 to $1 million with the phase-out limitation increasing from $2 million to $2.5 million for tax years beginning after December 31, 2017. These amounts are indexed for inflation for years beginning after 2018. The Section 179 deduction applies to tangible personal property such as machinery and equipment which is purchased for use in a trade or business. The new law increases the scope of qualified property to include “qualified real property” which includes the following improvements to nonresidential real property after the date the property was first placed in service: roofs; heating, ventilation, and air-conditioning property; fire protection and alarm systems; and security systems. Additionally, the provision is expanded to include certain depreciable personal property used to furnish lodging.
Shorter Recovery Periods for Farm/Ranch Equipment – For new farm/ranch machinery or equipment (other than any grain bin, cotton ginning asset, fence, or other land improvements) placed in service after December 31, 2017, the cost recovery period is shortened from seven to five years. Additionally, 3-year, 5-year, 7-year, and 10-year property used in an agricultural business may now be depreciated using the 200% declining balance rather than the 150% declining balance method which was required under the old law. This allows for larger depreciation deductions in earlier years.
Increased Luxury Auto Depreciation Limits – For passenger autos placed into service after December 31, 2017, the luxury auto depreciation limit has been increased from $3,160 to $10,000 for the first year the vehicle is placed in service, from $5,100 to $16,000 for the second year, from $3,050 to $9,600 for the third year, and from $1,875 to $5,760 for the fourth and later years. These amounts are indexed for inflation for years after 2018.
Elimination of Separate Categories for Qualified Real Estate Improvements – The new law eliminates the separate definitions for qualified leasehold improvement property, qualified restaurant property, and qualified retail improvement property and creates a general qualified improvement property category. As such, qualified improvement property placed in service after December 31, 2017 is generally depreciable over 15 years using the straight-line method. This change will negatively impact restaurants as newly constructed restaurant building structures that are not qualified improvement property will now be subject to a 39-year depreciation period rather than a 15-year period. Under the new law, only improvements to the interior of restaurant buildings, which must also meet the qualified improvement property requirements, may be depreciated over 15 years. Under the new law, qualified improvement property is eligible for Section 179 expensing and eligible for bonus depreciation due to the 15 year depreciation period assigned.