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July 26, 2018
The Tax Cuts and Jobs Act (TCJA) will have a significant impact on those in the construction and real estate industries. It's perhaps the most significant change to the tax law in over three decades, including reducing the top corporate tax rate to 21 percent, and providing a 20 percent taxable income deduction for owners of certain pass-through entities.
These two provisions alone will likely result in lower taxes paid by corporations and flow-through owners.
There are also hundreds of other new provisions, modifications, and repeals of existing provisions along with numerous effective and phaseout dates. For the purposes of this article, we are focusing on the changes to fixed assets and how they are impacting the construction and real estate industries.
Unless otherwise indicated, the following provisions are effective for tax years beginning after Dec. 31, 2017.
First-year bonus depreciation
Effective for qualified property placed in service after Sept. 27, 2017, taxpayers can deduct 100 percent of the cost of qualified business assets as additional first-year depreciation. The bonus depreciation provisions will apply to new and used assets and there are no income thresholds or phaseouts on the amount of bonus depreciation that can be taken each year.
The 100 percent bonus depreciation deduction is effective until Dec. 31, 2022, when it's scheduled to begin phasing out by 20 percent for each of the following four years, down to 20 percent in 2026 and completely phased out in 2027.
It's important to understand this phasedown schedule and plan for it accordingly as 100 percent bonus depreciation deductions won't be at 100 percent forever. For example, the difference between purchasing qualifying property in 2022 when it's eligible for 100 percent bonus depreciation versus in 2023 when bonus depreciation is at 80 percent could result in significantly different tax and cash flow implications for the company and its owners.
The benefit of Section 179 expensing is somewhat reduced due to the enhanced bonus depreciation provisions; however, the maximum amount a taxpayer can expense under Section 179 is increased to $1 million and the phaseout threshold is increased to $2.5 million.
The TCJA eliminates the asset classifications for qualified leasehold improvement, qualified restaurant, and qualified retail improvement property, but retains the classification for qualified improvement property (QIP).
QIP is any improvement to an interior portion of a nonresidential building if such improvement is placed in service after the date the building was first placed in service. It appears that the intent of Congress was to reduce the QIP recovery period to 15 years from 39 years and have it retain its bonus eligibility. However, in an apparent drafting error, the statute retains QIP's 39-year recovery period and eliminates its eligibility for bonus deprecation.
But, QIP is now eligible for Section 179 expensing which could help reduce the cash flow impact of making such improvements. For example, assume a flow-through company expends $1 million on QIP eligible for Section 179, such an expenditure could lead to $370,000 of current year tax savings at the highest rate of 37 percent to the owners rather than having to recover the cost of the QIP over a period of 39 years.
These accelerated tax benefits will be a crucial element in the cash flow analysis of capital investments going forward.
Further, the following building components are now eligible for Section 179 expensing provided they are installed after the date the building was first placed in service:
Fire protection and alarm systems
The TCJA modifies the Section 1031 like-kind exchange provisions by limiting their application only to real property. Taxpayers will no longer be able to defer the gain on vehicles, equipment, machinery, and other non-real property assets.
Overall, the TJCA changes to fixed assets remain favorable for taxpayers. With 100 percent bonus depreciation and increased Section 179 limits there will be more opportunities to expense qualifying costs immediately rather than having to recover them through regular depreciation deductions over a number of years.
It's important that taxpayers and their tax advisers review capitalization policies and upcoming capital expenditures to identify planning opportunities and take advantage of the new rules as they complete their cash flow analysis and refine their tax strategies.
Phil Knudson and Alex Ratner are CPAs and senior managers at Moss Adams.