Changes to Depreciation Under Tax Reform

The Tax Cuts and Jobs Act (TCJA), signed into law in the final days of 2017, contains many changes that impact depreciation rules. While these changes are largely positive, there are some potential pitfalls taxpayers should be aware of.

First-year bonus depreciation

The TCJA increases the bonus depreciation percentage from 50% to 100% for qualified property acquired and placed in service after September 27, 2017 and before January 1, 2023. It also expands the definition of property eligible for bonus depreciation to include used property as long as the taxpayer didn’t use the asset before acquiring it or acquire it from a related party.

Changes to the depreciation of leasehold improvements

Prior to the TCJA, three classes of leasehold improvements qualified for a 15-year depreciation period instead of the 39-year depreciation period typically applied to improvements of nonresidential rental property. Those three classes were:

  • Qualified leasehold improvements – made to the interior portion of a nonresidential building, pursuant to a lease between unrelated parties, and made more than three years after the building was first placed in service
  • Qualified retail improvement property – made to the interior portion of a building, used in a retail business, more than three years after the building was first placed in service
  • Qualified restaurant property – a building or an improvement to a building, more than 50% of the building’s square footage must be devoted to preparing or serving meals

There was also a fourth class of property:

  • Qualified improvement property (QIP) – made to the interior portion of a building which is nonresidential real property except improvements attributable to the enlargement of the building, any elevator or escalator, or the internal structural framework of the building. The property must be placed in service after the date the building is first placed in service.

If QIP also met the definition of a qualified leasehold, retail or restaurant improvement, it was eligible for a 15-year life. Otherwise, it had to be depreciated over 39 years but was eligible for 50% bonus depreciation in the year it was placed in service.

The TCJA attempted to streamline these convoluted rules by consolidating the above categories, making QIP the sole class of leasehold improvement property that qualifies for depreciation incentives.

However, the law was also supposed to amend Section 168 to provide a 15-year depreciation life to QIP. Unfortunately, due to a drafting error, the newly modified Section 168 doesn’t actually provide a 15-year life to QIP. Section 168(k)(2) allows bonus depreciation for any property with a depreciable life of 20 years or shorter. Because Congress neglected to include a provision giving QIP a 15-year life, it is still subject to a 39-year life. This will hopefully be one of many coming technical corrections. Until then, taxpayers should treat QIP acquired and placed in service after December 31, 2017, as 39-year property not eligible for bonus depreciation.

Expanded Section 179 expensing

The TCJA increased the maximum deduction for Section 179 property from $500,000 to $1 million and increased the phase-out threshold from $2 million to $2.5 million. This applies to eligible property placed in service in tax years beginning after 2017. The TCJA also expanded the definition of property that qualifies for Section 179 expensing to include qualified improvement property.

These are just a handful of changes included in the tax reform legislation. If you have any questions on how to take advantage of these provisions or others within the TCJA, please contact BSSF today!