One amendment to the Internal Revenue Code (IRC) that will have a major effect on businesses is the expansion of the bonus depreciation rules. Under IRC Section 168(k), first-year bonus depreciation increased from 50 percent to 100 percent on qualified assets purchased after September 27, 2017. While this retroactive provision of the Tax Cuts and Jobs Act (TCJA) affects 2017, it’s still temporary. Full immediate expensing is available on qualified assets placed in service before January 1, 2023, but the deduction will phase out by 20 percent in each subsequent year until it’s eliminated for tax years beginning after December 31, 2026. Similar to prior law, taxpayers are permitted to elect out of bonus depreciation for any class of property on an annual basis. Under §168(k)(10), taxpayers also can elect to apply 50 percent bonus depreciation to only the first taxable year ending after September 27, 2017. The election to apply 50 percent bonus depreciation affects all qualified property, not just a certain class.
What Property Qualifies?
Qualified property refers to tangible personal property with a depreciable life of 20 years or less, water utility property and certain computer software. The new law expands this definition to include used property, as long as it’s new to the taxpayer. This is a significant change from the previous requirement that the property’s original use began with the taxpayer. For a closer look at the changes the TCJA made to bonus depreciation, check out this summary.
Qualified Improvement Property (QIP)
The TCJA provides for a more simplified approach to classifying improvement property by eliminating three of the four previous categories: qualified leasehold, restaurant and retail improvements. Amended §168(e)(3)(E) references just one classification: QIP. To meet the definition of QIP, the improvement must be:
- Made to the interior portion of a nonresidential building, and
- Placed in service after the associated building
Any expenses related to the expansion of the building, the internal structural framework, elevators or escalators don’t qualify as QIP.
Under the new law, QIP kept its 39-year life, but due to an apparent legislative error, is not explicitly eligible for bonus depreciation. Taxpayers are hopeful for a technical correction that will grant this property a 15-year life, making QIP placed in service after December 31, 2017, eligible for 100 percent bonus depreciation.
Section 179 depreciation rules also have been expanded for tax years beginning after December 31, 2017. The maximum allowable deduction under §179 increased from $500,000 to $1 million, and the phase-out threshold increased from $2 million to $2.5 million of assets placed in service. Taxpayers now have the opportunity to take §179 on QIP and specific improvements that wouldn’t otherwise qualify, including roofs, HVAC units, fire protection systems and alarm and security systems.
Luxury Auto Rules
Luxury automobiles, generally defined as four-wheeled vehicles with an unloaded gross weight of 6,000 pounds or less, are subject to more stringent depreciation limitations. Under amended §280F, the depreciation limitations for these automobiles are increased as follows:
The allowable first-year bonus depreciation on luxury autos remains $8,000 per year, so for a luxury auto placed in service after December 31, 2017, the total potential deduction in year one would be $18,000 ($8,000 bonus plus $10,000 regular depreciation). However, annual depreciation is limited to the lesser of the §280F limitations, noted above, or the amount allowed under §168(k). As a result, in year two, the depreciation deduction would be the lesser of $16,000 under §280F or $0 under §168(k), since the asset would’ve been fully depreciated in year one under 100 percent bonus depreciation. Unfortunately, this means if you take 100 percent bonus depreciation on your luxury auto, the deduction will be $0 in years two through six. Under §280F’s catch-up rule, the unrecovered basis could begin depreciating in year seven, subject to the $5,760 yearly limitation.
A taxpayer purchases a luxury automobile in January 2018 for $35,000. The asset would be depreciated as follows:
- Year 1: $8,000 of bonus depreciation plus $10,000 allowed under §280F = $18,000 deduction
- Years 2–6: No depreciation deduction
- Years 7 and beyond: $5,760 yearly deduction allowed until fully depreciated
In contrast, an SUV or truck weighing more than 6,000 pounds isn’t subject to the luxury auto limitations and is therefore eligible for 100 percent bonus depreciation in 2018. This inconsistency in the new law may be remedied through either a legislative technical correction or guidance from the U.S. Department of the Treasury.
The TCJA created several tax-saving opportunities for businesses under §168(k) and §179 while creating potential pitfalls under §280F. Taxpayers should be aware of these changes to help increase their benefit. Contact Maggie or your trusted BKD advisor for more information.