By Michael D. Koppel, CPA, PFS, CITP, MBA
Retired Partner at Gray, Gray & Gray, LLP
Recently there have been significant changes in the tax treatment of capitalization and expensing of real estate. While the new rules are complex, it is important for all businesses owning real estate to understand the tax options now available.
The Protecting Americans from Tax Hikes Act of 2015 (PATH)
PATH made almost all of the tax extenders retroactive and either permanent or extended for a period of years. However, while many people are familiar with some of the most talked about changes, there are several other changes that can have a significant effect on real estate. The following is a list of some of these less widely discussed changes:
- Under the broader, new rules for Bonus Depreciation, qualified improvement to a property is any improvement to an interior portion of a building that is non-residential real property if the improvement is placed in service after the date the building was first placed in service. This excludes: 1) enlargements; 2) elevators/escalators; and 3) internal structural framework. Furthermore, the improvements do not need to be made pursuant to a lease.
- The relaxed rules for depreciation of property, as listed above, also apply to the Alternative Minimum Tax (AMT).
- While it is true that Bonus Depreciation has been extended for five years, this is not the whole story. The percentage of Bonus Depreciation allowed will be reduced by 10% per year beginning in 2018. Therefore, if you are making plans for acquisitions, it is important to remember the potential impact that this decrease could have on your business.
- Regarding air conditioning and heating units, there has been some disagreement between the IRS and many taxpayers/tax advisors. PATH removes this disparity, making it clear that all air conditioning and heating units qualify for Section 179, including qualifying portions of HVAC systems. And unlike some other portions of the legislation, this provision is not retroactive.
- The 15 year life of Qualified Leasehold Improvements, Qualified Restaurant Property and Qualified Retail Property was made permanent.
- The Section 179 real property write-off limit of $250,000 has been removed.
In addition to the aforementioned tax provisions, certain businesses should also take note of the following provisions:
- Revenue Procedure 2015-56 allows qualified retailers and restaurants to expense 75% of the qualified cost of remodel / refresh costs. The remaining 25% must then be capitalized and depreciated. This safe harbor only applies to businesses that have applicable financial statements.
- While the “repair regulations” have been finalized for awhile now, they are very complex in nature. The new rules require real estate to use a new “unit of property” classification. The repair regulations allow taxpayers to recognize a loss on the disposition of a structural component of a building, which may be a significant advantage for real estate owners.
A couple things to remember:
- Depreciation and immediate expensing (Section 179) relate to timing of the deduction. While most taxpayers’ immediate reaction is that current expensing (money in the pocket now) is always better, this is not necessarily true. This is true with long-lived assets such as real estate. Remember, careful tax planning is always important.
- Taxes are not static. Just because tax rules today indicate that a provision is permanent does not make it so. There is much discussion around possible tax reform. While no one knows for certain what will happen, tax reform may bring significant changes to the tax landscape.
This article offers a brief overview of many current aspects of real estate taxation but does not provide an in-depth review of the provisions. Taxpayers should discuss these and other tax issues with a qualified tax professional on a regular basis.