Bonus Depreciation: How Building Improvements Fell through the Cracks
posted Apr 12, 2019 by Parul Bansal in the Global Tax Blog
Qualified improvement property (QIP) isn’t eligible for bonus depreciation, due to an error when drafting the final version of the Tax Cuts and Jobs Act (TCJA). This was not Congress’s original intent. However, unless Congress enacts a technical correction, this unfavorable provision is here to stay.
To Expense or Not to Expense?
For income tax purposes, businesses can deduct their ordinary business expenses. But certain expenses — such as the cost of investing in machinery, equipment and other long-lived assets — can’t be immediately deducted. Instead, these costs generally must be capitalized (reported on the balance sheet), and then depreciated (expensed gradually over their useful lives). As a result, capitalizable assets with longer Modified Accelerated Cost Recovery System (MACRS) recovery periods are often sold or retired before they’re fully depreciated.
Over the years, lawmakers have used Section 179 and bonus depreciation deductions to encourage businesses to invest in these types of assets. These provisions of the tax law allow businesses to immediately expense an asset (or a large portion of its cost) in the year it’s placed in service.
What’s Changed under Tax Reform?
The TCJA allows 100% bonus depreciation for qualifying new and used assets with recovery periods of 20 years or less that are placed in service between September 28, 2017, and December 31, 2022. The bonus depreciation percentage will begin to phase out in 2023, dropping 20% each year until it expires at the end of 2026. (The phaseout reductions are delayed a year for certain property with longer production periods and for aircraft.)
The TCJA also consolidates different categories of building improvement under a single definition: qualified improvement property (QIP). Although Congress intended to assign this new category a 15-recovery period, this change wasn’t included in the statutory language of the final law. Therefore, QIP is technically ineligible for 100% bonus depreciation. Instead, building improvements are generally depreciable over 39 years.
Unless Congress passes legislation that corrects this drafting error, the rules for deducting the costs of building improvements under the bonus depreciation provisions of the TCJA will be significantly more restrictive than under prior law.
What About Sec. 179 Deductions?
But there’s a silver lining: For assets placed in service after December 31, 2017, the TCJA increases the Sec. 179 deduction from $500,000 to $1 million annually and increases the asset acquisition phaseout threshold from $2 million to $2.5 million. Both amounts are to be adjusted annually for inflation.
More assets qualify for the Sec. 179 deduction under the TCJA, including:
- Property used predominantly to furnish lodging, and
- Various nonstructural improvements to commercial property (such as roofs, HVAC equipment, and fire and security systems).
However, building improvements don’t qualify if they’re attributable to:
- The enlargement of the building,
- An elevator or escalator, or
- The internal structural framework of the building.
Your business still may be able to immediately deduct the cost of certain building improvements that qualify for the Sec. 179 deduction, if you haven’t exceeded the Sec. 179 deduction limit and asset acquisition phaseout threshold for the year.
Our tax professionals are atop the latest TCJA interpretation guidance — and we’re on the lookout for legislation containing technical corrections to the current law. In the meantime, contact us to determine the optimal tax treatment for your building improvements and other capital investments. We can help you minimize your tax bill.