The Protecting Americans From Tax Hikes (PATH) Act of 2015 (part of the Consolidated Appropriations Act, 2016, P.L. 114-113), presents some new opportunities for accelerated depreciation and expensing of qualifying real property that CPAs should explore with their business tax clients.
15-YEAR PROPERTY DESIGNATION MADE PERMANENT
As a general rule, the cost of commercial real estate improvements is recovered over 39 years via straight-line depreciation. Secs. 168(e)(3)(E)(iv), (v), and (ix) carve out three exceptions to this rule: qualified leasehold improvement property, qualified restaurant property, and qualified retail improvement property. As a group, these exceptions are called "qualified real property."
Qualified real property is allowed a quicker recovery period of 15 years using a straight-line method, although before the PATH Act, this allowance was temporary and was periodically extended, having most recently expired for property placed in service after Dec. 31, 2014.
Property is qualified leasehold improvement property if the improvement is:
- Made pursuant to a lease;
- Sec. 1250 property (i.e., structural);
- Not the result of a lease between related parties;
- For the interior of the building or a portion of it occupied exclusively by the lessee or sublessee; and
- Placed into service more than three years after the building was first placed into service.
Qualified leasehold improvements do not include:
- The enlargement of a building;
- Elevators and escalators;
- Structural components that benefit a common area; and
- Internal structural framework.
Qualified restaurant property is any Sec. 1250 property that is a building or building improvement if more than 50% of the building's square footage is devoted to the preparation of and seating for on-premises consumption of prepared meals.
Qualified retail improvements are costs associated with improvements to interior portions of a nonresidential building that are open to the general public and used in the retail trade or business of selling tangible personal property to the general public. Like qualified leasehold improvement property, qualified retail improvements must be placed in service more than three years after the building is first placed in service.
The PATH Act makes the 15-year recovery period permanent. Note that the recovery period is not elective. Failure to properly depreciate qualified real property over 15 years puts other 15-year property at risk for reclassification to longer recovery periods (see "Confusion Over Qualified Leasehold Improvements May Create Opportunity," by Chris Atwell, RSM, available at rsmus.com. Care should also be taken to distinguish the 15-year straight-line life of qualified leasehold improvement property from that of land improvement property, which taxpayers are allowed to depreciate over 15 years using the accelerated 150% declining balance, switching to the straight-line method for the first tax year for which using the straight-line method with respect to the adjusted basis as of the beginning of such year will yield a larger allowance.
SEPARATE SEC. 179 DOLLAR LIMITATION REMOVED
Under pre-PATH Act law, a taxpayer could elect to treat qualified real property as Sec. 179 property. However, the aggregate cost of the qualified real property that a taxpayer could elect to expense was subject to an annual limit of $250,000. The new law permanently extends the treatment of qualified real property as Sec. 179 property, applicable retroactively to 2015. For tax years beginning after Dec. 31, 2015, it also removes the annual $250,000 limitation for qualified real property (the overall Sec. 179 limit of $510,000 (for 2017), with a dollar-for-dollar phaseout threshold of $2,030,000 (for 2017), continues to apply).
Also, under prior law, Sec. 179 expenses attributable to qualified real property could not be carried over to later years. Qualified real property expenses in excess of $250,000 were treated as if no Sec. 179 election had been made. The PATH Act allows amounts disallowed because of the active business taxable income limitation and attributable to qualified real property placed in service beginning in 2016 to be carried to later tax years.
Qualified real property expenditures are treated as Sec. 179 property only if the taxpayer elects to include them for that tax year.
BONUS DEPRECIATION EXTENDED
To be eligible for bonus depreciation, an asset must be qualified property. Sec. 168(k)(2)(A) defines qualified property as property with a recovery period of 20 years or less, depreciable software other than Sec. 197 software, and water utility property. Before the PATH Act, a fourth category was qualified leasehold improvement property. Neither qualified restaurant property nor qualified retail improvement property that was eligible for 15-year depreciation was also eligible to be qualified property for the purposes of bonus depreciation unless it was also qualified leasehold improvement property.
However, beginning in 2016, for the purposes of calculating bonus depreciation, the PATH Act substituted for qualified leasehold improvement property a new category of assets called "qualified improvement property" (Sec. 168(k)(2)(A)(i)(IV), as amended by PATH Act Section 143(b)). Qualified improvement property is any improvement to an interior portion of a building that is nonresidential real property if the improvement is placed in service after the date the building was first placed in service.
Like qualified leasehold improvement property, qualified improvement property does not include any improvement attributable to the enlargement of the building, any elevator or escalator, or the building's internal structural framework. However, qualified improvement property is significantly more taxpayer friendly in its expanded description of the types of properties that do qualify. First, qualified improvement property does not require that the improvement be subject to a lease, so interior improvements made by the owners of an owner-occupied building that meet the other requirements for qualified improvement property may now qualify for bonus depreciation. The removal of the lease requirement also means that improvements made to property in a situation involving a related-party lease could qualify for bonus depreciation (see "PATH Act and Expanded Benefits for Real Property: A Case of True Déjà Vu?" by Heather Alley, partner at DHG, available at dhgllp.com. Thus, improvements made under a related-party lease may not qualify for the 15-year recovery period but may qualify for bonus depreciation. Second, there is no longer a three-year waiting period. Under the new rule, the improvement is eligible for bonus depreciation any time after the building is first placed in service. Last, there is no common area restriction. So, for instance, common area improvements in multi-tenant buildings and interior improvements in an owner-occupied building or tenant improvements in a less-than-3-year-old building are now eligible for bonus depreciation.
The qualified improvement property concept is specific to bonus depreciation only. Qualified improvement property expenses may also be eligible for Sec. 179 expensing but must be tested under the qualified real property definitions discussed above. It appears that most qualified retail improvements would be considered qualified improvement property. Qualified restaurant property that is eligible for a 15-year recovery period may not be eligible for bonus depreciation. For example, qualified restaurant property, unlike qualified improvement property, can consist of an entire building.
For taxpayers in restaurant or retail businesses or with business leasehold improvements, these PATH Act provisions may spell advantageous new ways to expense real property assets or accelerate their depreciation. CPAs with such clients should include analysis of the opportunities as part of their tax advising and planning going forward.
Dayna E. Roane (firstname.lastname@example.org) is a shareholder with Perry & Roane PC, Niwot, Colo.
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