Top 10 Things You Must Know Before Diving into TY 2024

Tax season prep isn’t for the faint of heart. The code keeps evolving, and it’s quite difficult to keep up with everything.

We therefore present The Top Things You Must Know for TY 2024:

10. Sec. 179 Limits Increase Again

· Overall expensing limitation: $1.22M (up from $1.16M in TY 2023)
· Phase out threshold: $3.05M (up from $2.8M in TY 2023)

In contrast to bonus depreciation, Section 179 expensing continues to permit the immediate expense of 100% of an eligible asset’s cost. Before bonus rates began to decline, both incentives were essentially equivalent. With bonus at 60% and dropping, Section 179 expensing may play a much larger role in tax planning moving forward.

Caveats:

• Section 179 expensing can only be taken on a trade or business, so it won’t apply to every real estate situation.
• The immediate benefit of Section 179 expensing is generally limited to profitable entities.
• The Deduction is generally limited to “small” or “medium-sized” companies due to the phase out threshold. If a firm gets too large and spends too much, the amount of the Deduction available to them begins to decrease until it phases out completely. For context, in TY 2024 companies that spend more than $4.27M on qualified assets will no longer be eligible for the Deduction.

9. Use Care with Land Allocation – All Methodology is not Equal

Land allocations are typically required for acquired properties, and the value is generally provided by the taxpayer. Per the IRS, it’s crucial to ensure that a “reasonable method of allocation” is used. If taxpayers choose an arbitrary methodology, this can complicate an otherwise straightforward project.

Ideally, the allocation should be based on relative FMVs. Tax assessor values may be used, but cannot be solely relied upon when better evidence exists to determine FMV. Additionally, if the property acquisition is part of the acquisition of a trade or business, the allocation must agree to what the buyer and seller report on Form 8594.

Using a more arbitrary approach may invite IRS scrutiny. Taxpayers should be encouraged to use the best possible methodology and document to avoid any issues.

8. IRS Updates Chief Counsel Memorandum Number 20214101F

Chief Counsel Memorandum 20214101F was released in October 2021 and expanded the minimum requirements for an R&D Claim.

The Memorandum established that the following had to be identified for each business component included in the claim:

1. All research activities performed
2. All individuals who performed each research activity
3. All the information each individual sought to discover

On June 18, 2024 the IRS announced that it is waiving the requirement to provide the second and third pieces of information at the time a refund claim is filed.

However, it’s important to note that if a claim is selected for IRS examination, they may request this information. Providers should still be collecting this data as part of due diligence, and should be prepared to submit upon request.

7. Bonus Rates at 60% for TY 2024 

Taxpayers have been fortunate enough to enjoy 100% bonus rates since the TCJA took effect in 2018. This incentive has been a tremendous source of benefit and boosted the utility of the cost segregation study. The TCJA established an unprecedented 10 years of predictable bonus rates, allowing taxpayers to plan ahead with certainty.  For TY 2024, the bonus rate is 60%. Rates are currently set to drop to 40% in 2025 and to 20% in 2026, before phasing out completely.

The big question of course, is will Congress intervene? (See #1.)

No matter what happens, it’s important to recognize that cost seg studies will continue to bring benefit at any bonus rate.  We do encourage clients to place properties in service before end of year – when possible – in order to capture the higher rate of depreciation. This is an important talking point with clients who are wrapping up projects towards year end.  Get a CO or TCO where possible.

6. Final Regulations on Prevailing Wage and Apprenticeship Requirements Released

On June 25, 2024, the IRS published final regulations regarding the Prevailing Wage and Apprenticeship Requirements (PWA) associated with energy-efficient incentives under the Inflation Reduction Act.

Taxpayers that meet the PWA Requirements may increase the value of the claimed energy incentive up to fivefold. The regulations – TD 9998 — will be effective 8/24/2024.

Topics addressed include:

– Taxpayer recordkeeping requirements
– Direction regarding wage determinations, especially for projects located offshore or spanning multiple geographic locations
– Steps to ensure “timely compliance”
– Resources for employees to report non-compliance
Further guidance is anticipated, with the Department of Labor and the IRS working on a Memorandum of Understanding to be signed by year end.

Additionally, after reviewing comments, the Treasury Department and the IRS determined that Section 179D allocation is outside the scope of these final regulations. Rules for Section 179D allocation will be addressed in future guidance.

5.     Major R&D Case Law Sets Precedents

Several major cases were recently settled in Tax Court, with wide-ranging implications:

• Harper v. Commissioner (T.C. Memo 2023-57, Filed 5.10.2023)
  • IRS told a design/build firm that their activities failed the 4-Part Test — a “design” isn’t a “product” and therefore doesn’t meet the definition of a “business component”
  • The Tax Court disagreed, stating that a “design” can be considered a “process,” “technique,” or “invention,” and as such can certainly meet the definition of a “business component”
  • This ruling has empowered architecture firms to confidently move forward with claiming the R&D Tax Credit
• Betz v. Commissioner (T.C. Memo 2023-84, Filed 7.6.2023)
  • Plaintiff designed custom-built oxidizers, and IRS disallowed claim entirely
  • Tax Court agreed, for several reasons:
    • Taxpayer did not prove their claim that the products were pilot models, as they were not used to evaluate/resolve product uncertainty
    • Taxpayer failed to substantiate that the wages claimed as QREs were incurred in connection with the performance of qualified activities
  • Ruling further establishes the importance of documentation tying wages to activities, and that the taxpayer carries the burden of proof to demonstrate “Elimination of Uncertainty.” Working with an experienced provider is key to successfully substantiating and claiming the Credit.

4.      1031 Exchange Workarounds

The 1031 Exchange has long been a viable strategy for deferring capital gains tax on the sale of real estate. However, taxpayers are subject to a strict timetable – the seller has 45 days to identify a replacement property and 180 days to close on it. (Keep in mind, the 45 days is a subset of the 180 days.)

These 45 days can pass in a blink, and sometimes a suitable property can’t be found, or doesn’t pass inspection, or a deal falls apart…

Instead of exchanging one property for a like-kind replacement property, many taxpayers are beginning to use Delaware Statutory Trusts (DSTs) in lieu of a replacement property.

In fact, investors are encouraged to make a habit of identifying a DST as a “replacement property,” just in case.

Another twist on the traditional “replacement property” is the Bonus Depreciation Fund. Particularly useful for those who want to offset their passive income, investment in a Bonus Depreciation Fund generally means investing in NNN lease properties, car washes, gas stations, etc. Investors can leverage bonus depreciation on these properties to massive passive income.

These strategies are also attractive to the investor looking to transition away from active property management, and to investors interested in diversifying their holdings.

3. Changes Coming to the Investment Tax Credit (ITC) 

On May 29, 2024, the IRS released Proposed Regulations that introduce a modified version of the traditional ITC Credit.  The date on which construction commences will determine whether taxpayers are eligible for the traditional Credit – Sec. 48 – or the modified, “technology neutral” Credit – Sec. 48E.

Implications for taxpayers moving forward are significant:

• All projects not grandfathered in before the IRA are subject to PWA Requirements. If PWA Requirements are not met, benefit will drop to 1/5 of maximum.
• Several technologies that were eligible for the Sec. 48 version of the Credit will no longer be eligible for the Sec. 48E

*There is one exception to the PWA Requirements under Sec. 48E – taxpayers putting small-scale projects of less than 1MW into service are not subject to PWA.

2. Revised R&D Tax Credit Form 6765

On June 21, 2024, the IRS released a new revised Draft of Form 6765, Credit for Increasing Research Activities.

The updated version of the Form includes:

• New Mini-Section above Section A
• New Section E: Adds a new question about methodology changes
• New Section F: A new section for old information – QRE details are now listed here
• New Section G: For each business component, taxpayers must provide —
  • EIN and principal business activity code of controlled group member conducting the QRAs
  • Business component’s name or unique alphanumeric identifier
  • Business component type
  • Description of information sought to be discovered
  • All QREs, with wages broken into buckets: wages for those who performed the research, wages for those who supported the research, wages for those who supervised the research.

Section G will require an extremely high level of detail and documentation in order to tie projects and costs to individuals.

Completion of Section G is optional for:

• Qualified Small Business (QSB) taxpayers
• Those with QREs < $1.5M and gross receipts <$50M

However, most taxpayers will find they require a more granular and robust study process to successfully claim the Credit moving forward.    Fortunately, the revision won’t be mandatory till TY 2025 (processing year 2026), giving taxpayers time to assess their reporting procedures.

1. Be Prepared for Post-Election Uncertainty

The Tax Relief for American Families and Workers Act passed the House 1/31, but lingered in the Senate. The Act contained several highly anticipated taxpayer-friendly provisions:

• Delayed implementation of mandatory amortization of Sec. 174 assets until TY 2026. This would mean that Sec. 174 expenses could be deducted or amortized in TY 2022, TY 2023, TY 2024, and TY 2025.
• Extension of 100% bonus depreciation for qualified property placed-in-service after 12/31/2022 and before 1/1/2026. Properties placed-in-service in TY 2023 would benefit from a retroactive 100% bonus rate, and properties placed-in-service in TY 2024 and TY 2025 would enjoy that rate as well. Property placed-in-service in TY 2026 would be treated with a bonus rate of 20%.

Only time will tell if these provisions will be revisited in the post-election period, and if/how they will be modified.

For the time being, taxpayers should recognize that these incentives are subject to change, and should consult with their financial advisors.

Additionally, Capstan will be staying on top of all breaking news and changes. Follow us on LinkedIn for real time updates.