Bonuses for Businesses: Trump's TCJA Incentivizes Real Estate Activity
As President Donald Trump promised, his Tax Cuts and Jobs Act (the “TCJA”) initiated an overhaul intended to simplify an otherwise arduous tax code. Businesses benefited in a number of ways beyond the celebrated reduction in the corporate tax rate. Enhancements to both bonus depreciation and expensing limits for qualifying property broaden business owners’ options for the treatment of real estate on their books.
Business owners must decide, upon acquisition of an asset, whether to expense that asset to immediately decrease annual profits, or to capitalize that asset to reduce profits gradually over the asset’s life through depreciation deductions. The IRS sets guidelines that reduce flexibility in this decision, but real estate purchases and improvements often fall in the grey area leaving the decision to business owners.
Bonus depreciation enhancements
Under pre-TCJA law, bonus depreciation was capped at 50 percent for tax years 2015-2017 and would decrease to 40 and 30 percent in 2018 and 2019, respectively, and phased out completely in 2020. Under the TCJA, businesses may deduct 100 percent of depreciation expenses incurred in the first year from qualified properties acquired and put into service between Sept. 28, 2017 thru Dec. 31, 2022, at which time the bonus depreciation amount declines by 20 percent each year.
Historically, qualified leasehold improvements, qualified restaurant property and qualified retail improvement property fit into the definition of qualified property eligible for bonus depreciation. Under the TCJA, these categories are consolidated into the expanded definition of qualified improvement property (“QIP”), which was intended to fit within the class lives of property eligible for the enhanced bonus depreciation. However, based on what amounts to a scrivener’s error, Congress removed QIP from the definition of qualified property (presumably to reduce the class life to 15 years) and omitted the necessary provision linking QIP to less-than-20-year class lives necessary to qualify.
Most expect the House Ways and Means Committee to amend this oversight in the coming months. The TCJA also removed limitations from the definition of QIP such as no longer requiring improvements to a leased building be made pursuant to a lease. Building enlargements still do not qualify for bonus depreciation.
Section 179 expensing enhancements
The TCJA increases the current expensing limit of $500,000 to $1 million for qualified real property. The $1 million ceiling is reduced by the amount which the cost of qualifying property placed in service during the taxable year exceeds $2.5 million. Both amounts are indexed for inflation beginning after 2018. Qualified real property now includes the QIP definition used in bonus depreciation and items such as security systems, fire protection and alarm systems, roofs, and HVAC systems added to nonresidential real property.
Other benefits to holding or investing in real estate under the TCJA
The TCJA maintained or added other benefits to real estate holders beyond the big-ticket items discussed above. The laws governing like-kind exchanges which permit business owners and investors to exchange similar property in a tax-exempt transfer no longer permit trading of tangible personal property, but still maintain the tax-exempt protections for real property.
Similarly, the TCJA created new deductions for pass-through income. The calculation, though difficult, allows business owners to deduct an additional 20 percent of REIT (Real Estate Investment Trust) dividends.
Certain businesses that do not qualify for interest expensing (or elect out) are required to depreciate real property and QIP under the alternative depreciation system, and therefore do not qualify for bonus depreciation. Under the TCJA, recovery periods are shortened for certain real property (from 40 to 30 years) and QIP (from 40 to 20 years) under the alternative depreciation system, further providing opportunities and incentives to invest in real estate.