Bonus depreciation has changed tremendously over the past few years as companies use it to focus on revitalizing and rehabbing their companies and properties.
In fact, it has been around for more than 15 years. Originally started as a way to reinvigorate the economy after Sept. 11, 2001, bonus depreciation allows for an immediate tax deduction on certain capital expenditures. At the time, it allowed for a tax write-off of up to 30 percent on equipment acquired for business use.
Initially, bonus depreciation helped companies who acquired equipment or made land improvements. But, these assets had to pass the “first use” test, which required that assets be brand new in order to qualify for bonus depreciation. Over the years, certain changes have been made to the regulations, including adjustments to the qualifying deduction percentage. This percentage has bounced between the original 30 percent and up to 100 percent, then back down to 50 percent in 2017.
In late 2017, the Tax Cuts and Jobs Act was passed, which allowed for bonus depreciation of up to 100 percent for the next five years. Bonus depreciation was expended by eliminating the “first use” test. This effectively makes the purchase of used property bonus eligible. This portion of the tax law was retroactive to property acquired after Sept. 27, 2017, subject to binding contract limitations. This means that eligible property in a real estate acquisition completed after this date is now bonus eligible, even if the property already existed at the time of acquisition.
Take, for example, a manufacturing property that was acquired in January 2018 for $5 million. If a cost segregation study is completed, it would break out the parking lot, landscaping and process equipment associated with the purchase. If this property amounts to 15 percent of the acquisition cost, or $750,000, all of this would be bonus eligible in 2018. This means the acquiring taxpayer could write off 100 percent of the $750,000 for 2018. This obviously makes the acquisition of existing property more valuable to the taxpayer. A subsequent renovation of the property would become more valuable as well.
In addition to the new bonus depreciation rules, the new law expanded the definition of “179 property” to include roofs, HVAC, sprinklers systems and Qualified Improvement Property when installed after the building is originally placed in service. This means that all of these assets are eligible for immediate write-off when installed. This deduction is limited to $1 million per year and starts phasing out once $2.5 million in eligible property is acquired.
Let’s expand on our initial manufacturing property example. Let’s assume that after the $5 million acquisition, the taxpayer immediately puts $1.5 million into the property. This $1.5 million is broken down as follows:
• $750,000 Roofing
• $250,000 HVAC
• $100,000 Carpet
• $100,000 Drywall
• $100,000 Lighting
• $100,000 Plumbing
• $100,000 Furniture
Immediately the taxpayer could take $1 million in “179 property” expense. If we assume that the taxpayer takes that on the roofing and HVAC, it leaves the carpet, drywall, lighting, plumbing and furniture as capital assets. However, under the new bonus rules, the carpet and furniture are now eligible for 100 percent write-offs as well. This means that of the $1.5 million in renovation costs, the taxpayer can write off $1.2 million.
But wait, it gets better, maybe. Under the new rules, the lighting, plumbing and drywall would be considered Qualified Improvement Property. This means they would have been “179 property” eligible if we had not used up our $1 million on the roof and HVAC. However, lighting, plumbing and drywall could potentially be bonus eligible in the future. The Tax Cuts and Jobs Act was supposed to include Qualified Improvement Property under the definition of 15-year bonus eligible property. Unfortunately, in the rush to pass the act, an error left it out of the definition for the bonus. In order to fix this error, a technical correction is expected to be passed in the future.
Even without the technical correction, this example illustrates why the new tax bill could lead to more revitalization projects. In this example, the taxpayer acquired a $5 million property, put in $1.5 million in renovations, but immediately received $1.95 million in deductions ($750,000 on the acquisition purchase and $1.2 million on the renovation). All in all, these changes to the tax law will make it more economically feasible for taxpayers to purchase and rehab older facilities instead of purchasing new facilities.