If your business plans to expand a property or recently made significant improvements, there are several new taxpayer-friendly provisions that may significantly reduce your tax liability for 2015 and beyond. However, there’s a phaseout plan, so taxpayers who act now may receive a greater benefit.
These provisions, which are part of the Protecting Americans from Tax Hikes (PATH) Act of 2015, include several key benefits:
- Recovery of depreciable property costs more quickly through bonus depreciation
- A new qualified real property category
- Long-term planning security for taxpayers using the Internal Revenue Code (IRC) Section 179 expensing election
- An extension for energy-efficient building deductions under IRC Section 179D
In this article, we’ll discuss the ins and outs of the new provisions as well as how taxpayers can capture the related benefits through a cost segregation study.
One big benefit is the renewal of a key tax savings mechanism: bonus depreciation. This enables businesses to recover the costs of depreciable property more quickly and enhances cash flow, a key advantage for businesses in investment mode.
The PATH Act broadened the scope of bonus depreciation with the new qualified improvement property (QIP) category, which is set to become available for use in 2016. The category removes the three-year building in-service restriction and the related-party lease limitation. This is particularly helpful for those without leases or with related-party leases, such as auto dealerships, hotels, medical clinics, and manufacturers. Both small and large companies can take advantage of this because bonus depreciation isn’t subject to an asset purchase limit or net income requirement.
For taxpayers placing property in service between 2015 and 2017, the bonus depreciation percentage is 50 percent. That drops to 40 percent for 2018 and 30 percent for 2019, after which the opportunity is set to expire.
Alternative Minimum Tax
Also beginning in 2016, the amount of unused alternative minimum tax (AMT) credits businesses may claim in lieu of bonus depreciation increases. This applies to new tangible property with a recovery period of 20 years or less, such as equipment and site improvements as well as off-the-shelf computer software, water utility property, and certain qualified real property.
The 15-year recovery period is now permanent for these qualified real property categories: qualified leasehold improvement property, qualified retail improvement property (QRIP), and qualified restaurant property. Improvements that don’t qualify as one of these categories may meet the more general requirements for QIP. This new category is depreciated over 39 years but is eligible for bonus depreciation. The QIP provision is currently set to expire when bonus depreciation is phased out at the end of 2019, but further clarification by the Internal Revenue Service is anticipated.
Section 179 Expensing Election
Taxpayers that use the IRC Section 179 expensing election now have some long-term planning security. Certain taxpayers can elect to expense tangible personal property and select qualified real property. Section 179 expensing allows an immediate deduction of the full value of the asset instead of recovering the costs more slowly through depreciation deductions over multiple years.
Section 179 expensing applies to both new and used property. Starting in 2015, the PATH Act makes the expensing limits of up to $500,000 for new or used assets permanent. The Section 179 expensing election is subject to a dollar-for-dollar phaseout once the cost of all qualifying property placed in service during the tax year exceeds $2 million. Without the PATH Act, the expensing limit and the phaseout amounts for 2015 would have been greatly reduced. Keep in mind the election can offset only net taxable income—it can’t reduce income below zero.
Section 179D Energy-Efficient Buildings
Another provision extended benefits for energy-efficient buildings and improvements through 2016. Eligible improvements include additions to interior lighting; heating, ventilation, and cooling (HVAC) systems; and building envelopes as part of ground-up new construction or remodels made between January 1, 2006, and December 31, 2016.
IRC Section 179D provides a financial incentive of up to $1.80 per square foot for commercial building efficiency improvements above certain thresholds. Those who can claim the deduction include:
- Owners and tenants of commercial properties who have built or installed improvements
- Architects or engineers who are the primary designers on government-owned energy efficient buildings
Depending on which state the facility is located in, a licensed contractor or professional engineer must model the energy performance of the building and compare it with a reference building that meets the minimum energy and power cost requirements under standards set by the American Society of Heating, Refrigerating, and Air-Conditioning Engineers.
A cost segregation study can help make the most of tax savings opportunities if you have plans to expand or make improvements. A study segregates construction costs into proper asset classifications and recovery periods for federal and state income tax purposes. The following are two different approaches to the same situation to help illustrate the importance of performing such a study.
Remodel Without Cost Segregation Study
A small independent hotel decides to undergo a $900,000 remodel to its lobby, gift shop, and guest rooms that will be placed in service in June of 2016. Without a careful review of construction costs through a cost segregation study, the taxpayer can only easily recognize $100,000 of carpeting as short-life property and is unsure if the remaining costs are real or personal property. Therefore, the taxpayer depreciates the remaining $800,000 of remodel costs over 39 years using the straight-line method.
Remodel with Cost Segregation Study
With a cost segregation study, the small independent hotel identifies an additional:
- $305,000 of casework, removable finishes, and certain plumbing and electrical components as five-year tangible personal property
- $50,000 of used HVAC units
- $40,000 of QRIP related to the gift shop
- $25,000 for an elevator upgrade (which doesn’t qualify as QIP)
- $380,000 for general interior improvements
In this scenario, the taxpayer elects to deduct all the used HVAC units and QRIP as Section 179 in the first year. The construction costs that are identified as tangible personal property will be eligible for 50 percent federal bonus depreciation, then the standard 20 percent first-year depreciation for five-year modified accelerated cost recovery system (MACRS) property, equaling $243,000 in total first-year depreciation with bonus.
The $380,000 relating to general interior improvements qualifies as QIP property, so it’s eligible for bonus depreciation even though it’s 39-year property. As you can see from the table below, careful examination of construction costs can greatly accelerate depreciation, which will defer current tax liabilities.
We're Here to Help
It’s easy to get lost when navigating tangible property tax incentives. Our professionals perform more than 300 cost segregation studies a year, and our Tangible Asset Incentive Services professionals can help qualify assets into accelerated depreciation classifications or immediate expensing.
If you have questions about how your business can benefit from these tax provisions or about claiming missed deductions, contact your Moss Adams professional or email firstname.lastname@example.org.