CREJ - Multifamily Properties Quarterly - January 2015
Politicians have been continually citing the need for comprehensive tax reform. While there has been little progress for comprehensive tax reform,-- there were significant rules issued relating to property that taxpayers should be aware of for 2014. In late December, Congress passed the Tax Increase Prevention Act, which retroactively extended many tax incentives that are very beneficial for business owners. Section 179 and Bonus Depreciation Among the many extenders are provisions for bonus depreciation and Internal Revenue Code Section 179 expensing, both of which allow taxpayers to accelerate deductions for qualified property made before Jan. 1, 2015. Bonus depreciation allows taxpayers to deduct 50 percent of the cost of qualified property in 2014, provided the property is placed in service during the 2014 tax year. The remaining 50 percent that is not deducted using bonus depreciation is depreciated in accordance with normal depreciable lives and recovery rates. The term “qualified property” includes: • Tangible property that has a recovery period not exceeding 20 years; • Certain computer software; • Water utility property; and • Qualified leasehold improvement property. In addition, the property must be original use. Congress defined the term “original use” as the first use to which the property is put, whether or not such use corresponds to the use of such property by the taxpayer. IRC Section 179 allows taxpayers to expense $500,000 worth of qualified fixed-asset purchases made during 2014. In contrast to the bonus depreciation rules, the availability of this enhanced deduction is not limited to new property; however, a taxpayer’s ability to use the full $500,000 election begins to phase out as total qualified investments meet and exceed $2 million. Taxpayers may use the IRC Section 179 deduction only to the extent they have positive taxable income. No such limitation exists for bonus depreciation, which can be used to create a tax loss. In addition to the taxable income limitation, IRC Section 179 can be used only to the extent there is income from the active conduct of a trade or business. Consequently, rental real estate, which the code defines as a passive activity, is unlikely to be eligible for IRC Section 179. Fortunately, this limitation does not apply to bonus depreciation. Unless there is additional Congressional action in 2015, both bonus depreciation and the $500,000 IRC Section 179 expense threshold discussed above expired Jan. 1, 2015. Taxpayers contemplating a cost segregation study should consider this when making a decision, as the availability of bonus depreciation may dramatically impact the present value calculation that is inherent in any cost-segregation analysis. Repairs and Maintenance Rules In addition to the accelerated depreciation opportunities, taxpayers need to be cognizant of the new rules related to repairs and maintenance. As a result of recently implemented Treasury regulations, taxpayers likely will need to file one or more changes in accounting method forms when filing their 2014 tax returns. Failure to do so could result in missed opportunities or unwanted consequences. The new regulations are extremely voluminous. The following are some examples of when a change in accounting form may need to be filed: • Change to deducting repair costs or capitalizing improvement costs, including a change to adopt the new unit of property and building system definitions; • Change to deducting non-incidental materials and supplies when used or consumed; • Change to deducting incidental materials and supplies when paid or incurred; • Dispositions of a building or structural component; • Dispositions of tangible assets (non buildings); and • Removal costs. The following examples illustrate a couple of opportunities that taxpayers may miss if the appropriate change in accounting method forms are not filed: Example 1: If a taxpayer disposes of a depreciable asset, including a partial disposition, and has taken into account the adjusted basis of the asset or component of the asset in realizing gain or loss, then the costs of removing the asset or component will not be required to be capitalized. Example 2: B owns and leases out space in a building consisting of 20 retail spaces. The space was designed to be reconfigured; that is, adjoining spaces could be combined into one space. One of the tenants expands its occupancy by leasing two adjoining retail spaces. To facilitate the new lease, B pays an amount to remove the walls between the three retail spaces. Assume that the walls between the spaces are part of the building and its structural components. The amount paid to convert three retail spaces into one larger space for an existing tenant does not adapt B's building structure to a new or different use because the combination of retail spaces is consistent with B's intended, ordinary use of the building structure. Therefore, the amount paid by B to remove the walls does not improve the building and is not required to be capitalized. These examples are just the tip of the iceberg in terms of the new repair regulations. The potential impact to taxpayers is far-reaching. 2015 is a critical year for taxpayers to discuss the opportunities and/or undesired impact related to changing tax code and regulations.