We’ve gotten so used to hearing that these provisions have been extended “as is” for another year that it’s easy to overlook some significant changes for commercial real estate clients in this year’s “extenders” bill.
In December of 2015, Congress passed the Protecting Americans from Tax Hikes (PATH) Act of 2015, affecting a number of tax provisions that, until now, have not been permanent parts of the Tax Code. This extenders package is different from many previous ones in that it actually makes some provisions permanent and it makes changes to some provisions that can be helpful to businesses. In particular, some of the changes made to Section 179 expensing and bonus depreciation may be of interest to commercial real estate clients. When combined with the recent tangible property regulations, the new law increases opportunities for your clients to accelerate deductions using cost segregation studies.
Section 179 Expensing
The Section 179 deduction for small businesses was made a permanent part of the tax code at its pre-2015 level of $500,000 per year. The extension is retroactive to 2015. As before, the deduction will phase out on a dollar-for-dollar basis when the cost of eligible property exceeds $2 million. However, the $2 million threshold and the $500,000 deduction limit will now be indexed for inflation beginning in 2016. For the 2016 tax year, no adjustment will be made to the $500,000 deduction, but the phase-out will start at $2,010,000.
The PATH Act did not change the limited applicability of section 179 expensing for commercial real estate. The provision still only applies to “qualified real property,” which is limited to:
- Qualified leasehold improvement property,
- Qualified restaurant property, or
- Qualified retail improvement property.
However, the Act did remove limitations on carrying forward Section 179 deductions that exceeded income in prior years.
A summary of PATH Act changes to Section 179 are as follows:
- The $500,000 limit is retroactive to 2015 and made permanent going forward;
- The deduction amount and phaseout threshold are indexed for inflation beginning with the 2016 tax year; and
- Beginning with the 2016 tax year, the normal Section 179 carry forward provision applies to qualified real property.
Bonus Depreciation Provisions
The PATH Act retroactively extended the bonus depreciation rules for MACRS property with a recovery period of 20 years or less. For property placed in service before January 1, 2016, the act basically extended the rules that had expired at the end of 2014. For property placed in service after December 31, 2015, there are some significant changes to consider.
Bonus depreciation will phase out as follows: 50% for 2015 – 2017, 40% for 2018, and 30% for 2019.
Prior to the PATH Act, bonus depreciation was available to commercial building owners for qualified leasehold improvement property only. Qualified retail improvement property and qualified restaurant property did not qualify unless they were also qualified leasehold improvement property.
Qualified leasehold improvement property placed in service after December 31, 2015 is no longer eligible for bonus depreciation. Instead, a more expansive “qualified improvement property” is eligible for bonus depreciation. Qualified improvement property is an improvement to the interior of a nonresidential real property that is placed in service after the date that the building was placed in service.
As a result of this change, the following requirements no longer apply: 1) the building must be in service for at least three years, 2) the improvements must be made pursuant to a lease, and 3) improvements to common areas are ineligible. However, certain improvements such as enlargements, elevators/escalators, and internal structural framework continue to be excluded. Unfortunately, qualified leasehold and retail improvement property, and qualified restaurant property are not eligible for bonus depreciation unless they are also qualified improvement property.
A summary of the PATH Act changes to bonus depreciation are as follows:
- The bonus deprecation was extended for five years: 50% (2015-2017), 40% (2018), and 30% (2019);
- Qualified improvement property placed in service after December 31, 2015 is eligible for bonus depreciation; and
- Qualified leasehold and retail improvement property, and qualified restaurant property are not eligible for bonus depreciation unless they are also qualified improvement property.
Cost Segregation More Important than Ever
The changes under the PATH Act make it more important than ever to properly classify improvements to commercial buildings. As a result cost segregation specialists will be in high demand to make the following classifications:
- Repairs expense resulting in an immediate tax deduction;
- Tangible personal property subject to shorter recovery periods and eligible for bonus depreciation;
- Qualified improvement property eligible for bonus depreciation
- Qualified leasehold and retail improvement property, and qualified restaurant property subject to a 15-year recovery period and Section 179 expense election, and qualification for bonus depreciation.
The misclassification of improvement to commercial buildings will likely result in missed tax deductions for bonus depreciation, Section 179 expense, and accelerated depreciation.
The PATH Act has created additional tax saving opportunities for commercial building owners for a limited time. As a result, it is more important than ever to engage qualified cost segregation professionals to assist with the proper classification of improvements to commercial buildings.
If you would like to talk with a CSP360 cost segregation professional about how these changes may affect your clients, please click the button to schedule a free 15-minute consultation.