On December 22nd President Trump signed Tax Cuts and Jobs Act as expected. This bill is the biggest tax reform the United States has seen in over 30 years. The bill contains many changes related to individuals, businesses, and specific industries. The real estate industry in particular will be impacted by the provisions related to expensing interest, depreciation and the recovery period for real property.
For tax years beginning after December 31, 2017 business entities, regardless of their form, will generally be subject to a limit on their business interest expense deduction. Unless an exemption applies, net interest expense in excess of 30% of the business’s adjusted taxable income will be disallowed. Real property trade or businesses may elect out of the interest deduction limit by using ADS recovery period for depreciation rather than the regular (shorter) recovery period. The limitation is applied at the entity level for partnerships and s corporations and any disallowed interest is then allocated to the partner or shareholder as excess business interest. Adjusted taxable income for this purpose will be computed without regard to any item of income, gain, deduction, or loss that is not properly allocable to a trade or business; any business interest or business interest income; any amount of net operating loss deduction; the 20-percent deduction for qualified business income of a pass-through entity under Code Sec. 199A; and for tax years beginning before January 1, 2022, allowable deduction for depreciation amortization, or depletion. Exemptions also apply for taxpayers with average annual gross receipts for the three tax years ending with the prior tax year that do not exceed $25 million, adjusted for inflation after 2018.
Increased Code Section 179 expensing will allow taxpayers to expense up to $1 million dollars with a phase-out threshold amount increased to $2.5 million for property placed in service in tax years after December 31, 2017. Additionally, the definition of “qualified real property” eligible for Code Sec. 179 expensing has been expanded to include some of the following improvements to nonresidential real property after the date such property was first placed in service: roofs, ventilation and air-conditioning property, fire protection and alarm systems, and security systems. Bonus depreciation, beginning for items placed in service after September 27, 2017 and before January 1, 2023, is increased from a 50% deduction to a 100% deduction. Bonus depreciation, during this time period, is also expanded to apply to used property meeting specific acquisition requirements whereas under the old law bonus only applied to new.
Under current law improvements to real property fell into many separate definitions including, qualified improvement property, qualified restaurant improvement property, etc. The new law removes the separate definitions. Assuming a technical correction is made to the final bill, additions defined as qualified improvement property will be depreciated straight-line over 15 years or 20 years if the aforementioned interest expense election is made. If no correction is made, all such property will be depreciated as nonresidential real property and depreciated over 39 years.
Contact the Real Estate Team at HLB Gross Collins, P.C. to discuss in more detail the provisions identified above.
-by Abigail Hampton, CPA