In this blog, we will discuss the tax rule changes for depreciation and like-kind exchanges. The Tax Cuts and Jobs Act amends Section 168(k) and temporarily permits taxpayers the opportunity to immediately deduct the full cost of qualified property acquisitions. The bonus depreciation deduction is increased to 100% for qualified property acquired and put in service after September 27, 2017 and before January 1, 2023. Thereafter, the bonus depreciation for qualified property additions in 2023 is 80%, for qualified property additions in 2024 is 60%, for qualified property additions in 2025 is 40% and for qualified property additions in 2026 is 20%. Previously, bonus depreciation only applied to new property additions but the new rules apply to both new and used property acquisitions.
Qualified Property Defined
Qualified property includes Modified Accelerated Cost Recovery System (MACRS) property with a recovery period that does not exceed 20 years, computer software, water utility property, qualified film, television and live theatrical productions, and certain aircraft. Qualified property excludes foreign use property and intangible property. The original use of the property must begin with the taxpayer or the property must not have been previously owned and used by the taxpayer or a related party. In addition, the tax basis in the property must not have been determined in whole or in part by reference to the adjusted basis of the property in the hands of the party from whom it was acquired. Qualified property excludes any property used in a trade or business that is not subject to the 30% net interest expense limitation rules contained in the Tax Cuts and Jobs Act and Section 163(j) as amended, which are electing farming or real property businesses or regulated electrical, water, sewage, or gas businesses described in Section 163(j)(7)(A)(iv). Small businesses with annual gross receipts of less than $25 million and therefore not subject to Section 163(j) are eligible for bonus depreciation.
A glitch in the drafting of Section 168 appears to exclude qualified improvement property from qualified property eligible for bonus depreciation. The Tax Cuts and Jobs Act struck the language in Section 168(e) regarding qualified leasehold, restaurant, and retail improvements and replaced it with a single definition for qualified improvement property in Section 168(e)(6). However, counter to language in the Conference Committee Report[1], qualified improvement property was not actually given a 15-year MACRS recovery period in the legislative text. As bonus depreciation is only available on property with a MACRS recovery period not exceeding 20 years, qualified improvement property may not be eligible for bonus depreciation until Congress passes a technical corrections bill. Taxpayer’s will likely depreciate Qualified Improvement Property over a tax period greater than 20 years (i.e. 39-year non-residential) without additional guidance or correction surrounding qualified improvement property.
The Tax Cuts and Jobs Act is silent with respect to the determination of the acquisition date of self-constructed property. Until the IRS issues guidance, it is uncertain if the IRS will use the existing rules for acquisition date applicable to prior years bonus depreciation for self-constructed property contained in the 2003 regulations.
Impact of Bonus Depreciation on M&A
The new 100% bonus depreciation rules may dramatically impact M&A by making asset acquisitions and deemed asset acquisitions via Section 338 or Section 336(e) elections, more attractive due to the broadening of qualified bonus-eligible property to include used assets and the new limitation on post-acquisition NOL deductions to 80% of taxable income.
Section 179
The Tax Cuts and Jobs Act also increases the Section 179 expensing election for property placed in service after 2017 to $1 million subject to an increased phase-out limitation amount and expands the eligible property to include depreciable tangible property used in connection with furnishing lodging and certain improvements to nonresidential real property.
Like-Kind Exchanges
The 2017 Tax Act restricts the scope of IRC Section 1031 like-kind exchanges to apply only to exchanges of real property not held for sale (i.e. disallows exchanges of tangible personal property or intangible property). The new provision is effective for exchanges completed after December 31, 2017, with a transition rule applying to exchanges in which the property to be exchanged was disposed of or received on or before December 31, 2017. Like-kind exchange treatment is expanded to cover an interest in a partnership which has made an election under IRC Section 761(a) to exclude the entity from partnership treatment under Subchapter K. The partnership interest is then considered to be an interest in each of the assets of the partnership. To the extent that the partnership’s assets are real property, they are eligible for like-kind exchange treatment.
We hope this post was helpful as you assess the impact of tax reform on your business. GTM will be publishing regular posts highlighting key features of tax reform. Visit our tax reform page for the latest U. S. tax reform updates.