Bonus depreciation provisions under pre-Act law allowed businesses to deduct 50% of the cost of certain eligible depreciable tangible personal property and realty improvements in the year placed in service under a variety of specific subcategories.
- The Act is intended to change prior law, as clearly evidenced in the accompanying Joint Explanatory Statement, by doubling the bonus depreciation rate to 100% and consolidating the eligible property categories into a new single QIP category eligible for bonus depreciation (the “Act bonus depreciation framework”). The Act retains the election not to claim bonus depreciation, and adds a one-year provision to use 50% bonus depreciation solely for property acquired in the first taxable year ending after September 27, 2017. Cost basis not recovered under a bonus depreciation allowance may be recovered under regular depreciation methods.
- A second major change under the new bonus depreciation framework is the elimination of a “first user” requirement of pre-Act law. Taxpayers may claim bonus depreciation on property with a prior use history (if acquired from an unrelated party).
- For tax years after 2022, under the new Act bonus depreciation framework the allowable expensing percentage steps down in 20 percentage point increments, ending in 2026 with a rate of 20%, and is completely phased out thereafter.
- Due to legislative drafting oversight, specifically, Section 168(e)(3)(E) -- the provision generally describing property to which a 15-year recovery period applies -- was not properly amended to include QIP.
- Until a technical correction or interim IRS pronouncement is made, the treatment of property meeting the QIP criteria will be uncertain. However, given the centrality of these provisions to spur capital investment, a fix should occur and be retroactive to January 1, 2018. The present interim uncertainty may well slow capital investment in 2018 (that might otherwise occur without the legislative defect).
- Real estate businesses are front line beneficiaries of the Act bonus depreciation framework applicable to qualified improvements, though bonus depreciation may result in negative effects under New York tax law, based on positions of the NYS Department of Taxation that require NYS adjustments to federal income even where there is no federal tax benefit obtained (a problem existing before the Act).
The Act did not shorten the general period for depreciation of real estate under the regular MACRS method (as the Senate and Joint Committee versions of the bill did not adopt the House approach to shorten regular depreciation periods under MACRS to as short as 25 years). Regular MACRS continues to depreciate non-residential real property (buildings and structural components) over 39 years and residential rental property (buildings and structural components) over 27.5 years.
The new law, however, makes the following changes for property placed in service after 2017:
- Adding a new 15-year depreciation period for QIP (replacing the pre-Act categories of qualified leasehold improvements, qualified restaurant property, qualified retail improvement property, and qualified improvement property) significantly without regard to pre-Act requirements that the improvements are subject to a lease, placed in service more than three years after the date the building was first placed in service, or made to a restaurant building. Due to the Act drafting error noted above, the Code was not properly amended to provide for the new QIP category as 15-year property.
- Shortening to 30-years the depreciation period under the Alternative Depreciation System (ADS) for residential rental property (from 40 years), with no change in the 40-year ADS depreciation period for nonresidential property, and shortening to 20 years ADS depreciation for certain qualified interior building improvements.
Real estate businesses that elect out of the new 30% of ATI limitation on business interest expense (see discussion above) are required to use ADS depreciation.
- The Act largely retains MACRS but introduces the newly defined QIP category qualifying for 15-year depreciation and shortens some ADS recovery periods (to periods not substantially longer than general MACRS recovery periods). The ADS recovery periods apply to real estate businesses electing out of the Interest Limit. Critically, as noted above in the depreciation discussion, interim IRS guidance and technical correction legislation is needed to clarify the treatment of QIP for purposes of the intended 15-year MACRS recovery period and eligibility for bonus depreciation. Due to the centrality of the Act bonus depreciation framework, one would expect that to occur in early to mid-2018 and be fully retroactive.
- Clients investing in QIP need to be speaking closely with their tax return preparers regarding the appropriate treatment under the bonus and regular depreciation rules.