TCJA – Tax Cuts and Jobs Act (H.R.1) of 2017

The Tax Cuts and Jobs Act was signed into law on December 22, 2017. This marked the first comprehensive tax law reform since 1986, and has had an impact on every American taxpayer and industry. The TCJA brings new opportunities, as well as some challenges, to the commercial real estate community.  Most of the legislation became effective January 1, 2018, with two important exceptions.

Capstan Tax Strategies is at your service as we navigate these changes together.  We’ve done a thorough review of the TCJA-  Tax Cuts and Jobs Act and analyzed the legislation most likely to have a major impact on our clients and colleagues.  (Click HERE if you’d like to read the Act in full).

Corporate Tax Rate

  • The top corporate tax rate of 35% was reduced to 21%. Corporate AMT was eliminated.

Interest Deduction Limitation

  • For years beginning 1/1/2018, companies are subject to a limitation on deductible interest expense. The deductible amount is capped at 30% of adjusted taxable income, after certain adjustments.
  • Companies that are “real property development, redevelopment, construction, reconstruction, acquisition, conversion, rental, operation, management, leasing or brokerage trade or business” may “elect-out” of this limitation. However, any company that elects-out of the interest limitation will be required to depreciate its real property using the Alternative Depreciation System (ADS).

For a company electing-out for tax years after 12/31/17, the ADS lives below are applicable:

  1. Residential real property assets are 30 years straight line.
  2. Nonresidential real property assets are 40 years straight line.
  3. Qualified Improvement Property are 20 years straight line for ADS.
  • If a company does not elect-out of this limitation, they may continue to depreciate assets using the current MACRS class lives.
  • There is one major exception to the above. If a firm’s three-year average annual gross receipts are $25M or less yearly, it is completely exempt from the deduction limitation and may continue to depreciate real assets utilizing MACRS class lives.  (Aggregation rules may apply for related entities.)

Capstan’s Take

ADS lives are obviously longer than MACRS class-lives, and, as will be discussed below, assets depreciated using ADS lives are not Bonus-eligible under the TCJA.   As such ADS may be considered somewhat punitive from a depreciation perspective.    In general, many taxpayers would prefer to continue to utilize MACRS depreciable lives.  Fortunately, the small business exemption mentioned above applies to many of Capstan’s clients.  These clients could therefore continue to utilize MACRS depreciable lives while avoiding interest deduction limitations.    Taxpayers need to think about whether they would be eligible for this exemption and if not, to carefully weigh the benefits and costs of choosing to elect-out of this limitation.  Capstan has developed a helpful graphic to aid in making this decision.

Bonus Depreciation

  • Bonus depreciation has been changed and is one aspect of the TCJA that is retroactive. This may have an impact on your 2017 filing.
  • Bonus depreciation was established at 50% for TY 2017 under the PATH Act.
  • The TCJA increases Bonus to 100% for properties acquired and placed-in-service after 9/27/17 all the way through 2022. After 2022, Bonus rates will gradually decline as follows:

  • Properties with longer production periods will have an additional year added to each of the above timeframes, i.e. 100% Bonus from 9/28/17-12/31/23.
  • Properties depreciated using ADS lives are generally not eligible for Bonus.
  • Under the PATH Act, only new assets were Bonus-eligible. Under the TCJA, acquisitions are also eligible for Bonus treatment.  Qualifying assets no longer have to be new to be Bonus-eligible; they just have to be “new to you.”
  • The date 9/27/17 is now very significant in determining proper application of Bonus rules. The IRS has not yet issued further guidance for TCJA, so the Capstan team is interpreting the law according to guidance issued when the IRS last did a mid-year split of Bonus rates in 2010 (Reg. 1.168(k)-1(b)(4) and Revenue Procedure 2011-26).  As such, the following is subject to change:

Acquired Property – Bonus Rate Driven by Date of Signing of Written Binding Contract (WBC)

New Construction/Renovation – Bonus Rate Driven by Date “Substantial” Construction* Begun

*In general, manufacture, construction, or production of property begins when physical work of a significant nature begins.  This does not include preliminary activities like planning, designing, securing financing, exploring, or researching.   The IRS does offer a Safe Harbor Option, in that physical work of a significant nature will not be considered to begin before the taxpayer incurs or pays more than 10% of the total cost of the property.

Capstan’s Take

Boosting Bonus is certainly a gift to taxpayers – the ability to completely expense the asset in the year it was placed-in-service is invaluable.  Eliminating the requirement that Bonus-eligible assets be new just expands the benefit. This boosts the potential of a cost segregation study on an acquired property, and Capstan clients may choose to revisit and reassess those opportunities.  We are already seeing clients increase their first year tax savings by over 500% under this new legislation.

Taxpayers do need to be aware of the written binding contract rules to ensure that they are properly applied regarding acquired properties.  Furthermore, they need to understand the nature of work that may be considered “substantial” construction.  We encourage clients to consult with their CPA and/or attorney to determine the critical dates involved in their projects.

It is crucial to recognize that electing out of the interest deduction limitation described above will mandate the use of ADS for depreciation and therefore eliminate Bonus-eligibility.  This could result in significant loss of savings, particularly in light of the expanded scope of Bonus depreciation under the TCJA.  Taxpayers must select the most advantageous strategies based on their particular facts and circumstances.  The Capstan team strongly recommends consultation with a tax professional.

 

Qualified Improvement Property (QIP)

  • QIP was established by the PATH Act in 2015, and defined as any improvement to an interior portion of a building which is nonresidential real property if the improvement is placed-in-service after the date the building was placed-in-service.
  • QIP was quite different than the other three categories of qualified property.
    • Qualified Leasehold Improvements (QLI), Qualified Restaurant Property (QRP), and Qualified Retail Improvements (QRIP) were all limited by various conditions that did not apply to QIP.
    • Furthermore, QIP was classified as 39-year class life after Bonus, while oddly, the other three property categories were all classified as 15-year SL.
    • Most significantly, the PATH Act established QIP as the only property category eligible for Bonus after 1/1/2016.
  • The TCJA amended Section 168 to eliminate any reference to QLI, QRI, and QRIP. As of 1/1/2018 these categories of qualified property no longer exist, but instead are gathered in under the broad umbrella of QIP.
  • Congress intended to assign QIP property placed-in-service post-12/31/2017 to a 15-year SL recovery period. Section 168(e)(3)(E) is the subparagraph that lists assets eligible for a 15-year class life. In a drafting error, this “new” QIP was never actually included in that subparagraph.
    • However, Section 2307 of the CARES Act of 2020 corrected this error, assigning a 15-year depreciable life to QIP placed-in-service after 12/31/2017, thereby allowing it to be characterized as qualified property eligible for bonus depreciation.

Capstan’s Take

By eliminating QLI, QRI, and QRIP with all their associated restrictions, the TCJA has streamlined the treatment of certain real property.  

The long-awaited retroactive correction of the QIP “glitch” is good news for taxpayers.  Now that QIP is eligible for 100% bonus depreciation through 2022, many are revisiting past projects to benefit from this legislation.  Taxpayers are also considering future renovations with more confidence, since they will be able to fully expense qualified improvements.

 

Section 179 Expensing

  • Section 179, an entity-level election, permits the full purchase price of a qualifying asset to be written off completely in the year of purchase. Qualifying assets included business equipment, computers, business related vehicles, etc. and the election has long encouraged businesses to invest in their own growth.
  • Effective 1/1/2018, the TCJA expands the eligible assets to include the following improvements to nonresidential building systems placed-in-service after the building was placed-in-service:
    • Qualified Improvement Property (QIP) and,
    • Roofs
    • HVAC
    • Fire protection and alarm systems
    • Security systems
  • Furthermore, the TCJA increases the dollar limitation of the election from $510K to $1.0M beginning in TY 2018.
  • The exclusion of tangible personal property used in connection with lodging facilities (i.e. hotels) has been eliminated by the TCJA.
  • Section 179 property may be new or used.

Capstan’s Take

Expanding the scope of 179-eligibility to include the above building improvements further expands the utility of cost segregation.  Carving out these assets is a natural part of an engineering-based study.  Couple the expanded scope with an almost 50%  increase in the maximum expenseable amount, and we’re looking at a potentially valuable new strategy for the commercial real estate owner.

Until 1/1/2018, property used to furnish lodging did not qualify for expensing.  The TCJA eliminates that provision, meaning that assets used in hotels, motels, and dormitories may now be eligible for expensing under Section 179.

We strongly suggest consultation with a tax professional to discuss the interplay between Bonus Depreciation and 179 expensing.

 

State and Local Tax Deductions (SALT)

  • The TCJA limits annual itemized deductions for all nonbusiness state and local tax deductions, including property taxes, to $10,000. Previously, there was no cap on this deduction.

Capstan’s Take

There’s no way around it… yet.   The cap on SALT deductions is going to increase the tax liability of many of Capstan’s clients, particularly those doing business in heavily taxed states like NY, NJ, CT, IL, and CA. These taxpayers may want to seek new sources of deductions, and cost segregation studies may be particularly valuable here.

We do expect to see litigation at the state level to combat this limitation, as well as some creative state legislation.  For the moment though, taxpayers in highly taxed states may take a real hit.

 

Like-Kind Exchanges

  • Effective 1/1/2018, like-kind personal property exchanges are no longer permissible.
  • However, Section 1031 real estate like-kind exchanges are preserved and will continue to be eligible for tax deferral.

 

In Summary

The TCJA certainly brought a lot of changes, but opportunity has come along as well.

We’ve developed a new version of the famous Depreciation Accelerator that focuses on real estate in the post-TCJA era.  This document is a great one-page resource that summarizes a lot of the information above in a streamlined, accessible way.  

 We developed a new slate of in-house and virtual CPE presentations to walk you through these changes. The Capstan team is here to collaborate with you as you move forward.  We are honored to be your trusted partner, and we look forward to helping you make sense of, and make the most of, the Tax Cuts and Jobs Act. 

References:

  1. 1.168(k)-1(b)(4) and Revenue Procedure 2011-26 (Old implementation rules for WBCs and use of Bonus depreciation)
  2. Code Sec. 168(k)(9), as added by the 2017 Tax Cuts Act (Section on floor plan financing that disqualifies it from Bonus)
  3. Act Sec. 13201(h)(1) of the 2017 Tax Cuts Act (The WBC rules described by the TCJA)
  4. Code Sec. 179(f) (Adds Roofs, HVAC, Fire Protection and Security Systems to Sec. 179)
  5. L. 115-97 (Authorizes QIP with a 15-year life, removes QLI, QRIP, and QRP)
  6. Code Sec. 168(k)(1)(A) and (6)(A), as amended by the Tax Cuts and Jobs Act (P.L. 115-97) (Authorizes Bonus depreciation at 100% after 9/27/17)
  7. Code Sec. 163(j), as amended by the Tax Cuts and Jobs Act (P.L. 115-97) (Limits business interest deduction for taxpayers with average annual gross receipts over $25M)

Services for CPAs

In the face of growing tax code complexity, it’s almost impossible to cover every area with in-house resources. For expertise in understanding and applying the myriad of complexities with the Tangible Property regulations and other IRS Code impacting commercial real estate, turn to Capstan Tax Strategies.

Services for Business Owners

Accelerating depreciation has long been a strategy employed by real estate owners to take advantage of immediate tax savings. The Tangible Property Regulations and the recent Tax Cuts and Jobs Act has created significant opportunities that elevate the many uses of Cost Segregation Studies. Learn how Capstan can help.

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