Frank C. Mayer
On Dec. 22, 2017, President Trump signed into law the Tax Cuts and Jobs Act. The Act has effectively reduced the acquisition cost of certain capital assets by making significant changes to the rules for bonus depreciation and capital expenditures, commonly known as Internal Revenue Code Section 179 Expensing and certain other depreciation.
Prior to the Act, taxpayers were allowed to deduct 50 percent of the cost of most new tangible personal property and most new computer software in the year that an asset was placed in service. Because of the bonus depreciation deduction allowed in the year an asset was placed in service, there was a corresponding reduction in the amount of regular depreciation allowed in that year and later years.
For qualifying property placed in service after Sept. 27, 2017, and before Jan. 1, 2023, the Act raised the 50 percent bonus depreciation deduction rate to 100 percent.
Moreover, under the Act, the property eligible for bonus depreciation can be either new or used (used property is ineligible if it was acquired from a related party or it was previously used by the taxpayer). The 100 percent bonus depreciation is to be phased down to 80 percent for property placed in service in calendar year 2023, 60 percent in 2024, 40 percent in 2025, 20 percent in 2026 and to 0 percent for calendar year 2027 and thereafter. Bonus depreciation automatically applies to all eligible property at its full cost (less any amounts expensed under Code Section 179). The taxpayer may elect out of bonus depreciation on a timely filed return, but must do so for an entire class of property and cannot do so on an asset-by-asset basis.
Prior to the Act, many smaller taxpayers could elect, on an asset-by-asset basis, to fully deduct the cost of certain Code Section 179 property up to an annual limit of $500,000 adjusted for inflation. For assets placed in service in tax years beginning in 2018, this was $520,000.
The annual limitation was reduced dollar-for-dollar for the cost of all of the Code Section 179 property that the taxpayer placed in service during the tax year in excess of $2,000,000, adjusted for inflation, which for 2018 was scheduled to be $2.07 million. The Act increases the annual dollar limit to $1 million, the amount of which is adjusted for inflation beginning after 2018, and $2.5 million as the threshold for phase-out, which is also adjusted annually for inflation following 2018.
However, the Code Section 179 Expensing Deduction is limited to the taxpayer’s taxable income from all active trades or businesses. Any amount that cannot be deducted by the taxpayer can be carried forward to later years until fully deducted. Unlike bonus depreciation, Code Section 179 expensing may be applied on an asset-by-asset basis.
The Act also replaced a narrow exception under Code Section 179 for certain “qualified real property” which included restaurant buildings and certain improvements to leased space, retail space and restaurant space. For tax years beginning in 2018, those exceptions are removed from the definition of qualified real property and have been replaced by a wide range of improvements made to nonresidential real property.
These include: (i) any building improvement to an interior portion of a building other than the enlargement of the building, any elevator or escalator, or changes to the internal structural framework of the building; and (ii) building components consisting of roofs, heating, ventilation and air conditioning property, fire protection and alarm systems and security systems.
Other rules for depreciation include:
Vehicles. The Act significantly increases the annual dollar limit on depreciation (and Code Section 179 expensing) of passenger automobiles and small vans and trucks. In addition, because of the expansion of bonus depreciation, the increase for vehicles eligible for bonus depreciation is extended until 2026, without a phase down.
Computers and certain peripheral equipment. Under the Act, computers or peripheral equipment placed in service beginning in 2018 are not treated as “listed property” whether used in a business setting or home office and whether or not, in the case of an employee, its use is for the convenience of the employer. As such, an asset is no longer required to meet the more-than 50 percent qualified business-use test to be eligible for the Code Section 179 expense deduction. This means a taxpayer may be able to claim the Code Section 179 deduction for certain property that is not predominantly used for business.
Taxpayers interested in making capital expenditures to maintain or expand their business should consult with their tax advisor as to how these changes may present opportunities to reduce the cost of acquiring certain capital assets.
Mayer is a member of Bond Schoeneck & King.