Small Business Taxes & ManagementTM--Copyright 2018, A/N Group, Inc.
If you haven't read the introduction to our first article on the new law, please go to Tax Cuts and Jobs Act--Part 1. In this installment we're continuing our discussion of items affecting individuals. There are a number of changes to the provisions applicable to business. Many are straight-forward, some are complex and will require regulations by the IRS to fully implement. We'll start this discussion with some of the easier ones.
Section 179 Expensing Depreciable Assets
There are a number of ways of treating depreciable tangible personal property and certain other qualifying real property. Taxpayers can expense an asset with a cost of no more than $2,500 ($5,000 for certain taxpayers) under a safe harbor rule. That works well for small items such as laptops, calculators, small tools, etc. largely because it involves less paperwork and follows financial accounting rules. But there are some restrictions. For larger assets Section 179 allows an immediate deduction, but you must make an election to do so. In addition, there's an income limitation. But it's still simpler than taking annual depreciation.
Under prior law the Section 179 election was limited to $510,000 (adjusted for inflation) of assets in any one year and that amount was decreased for taxpayers who put more than $2,030,000 of tangible personal property in service during the year. There was a $25,000 restriction on SUVs (not adjusted for inflation) and for property used in connection with certain lodging facilities.
Increased Expensing Limits The new law increases the amount of property that can be expensed in any one year to $1 million and the investment limitation is increased to $2.5 million from $2 million. The higher $1 million limit on qualifying property means many small businesses won't have to worry about depreciation of most assets. By combining the $2,500 safe harbor for lower-cost assets and the Section 179 option, over $1 million can be written off in any one year.
Tax Tip--Taxpayers doing business as a pass-through entity (S corporations, partnerships, etc.) may not want to use the full available amount. That's because of the graduated rates for individuals where the pass-through income is taxed. Taking a large deduction in one year that drops your income into a low bracket only to push yourself into a high bracket in the following year will result in overall higher taxes. You do have some options and you don't have to decide to depreciate or expense an asset until you file your return.
Qualified Real Property Definition The provision expands the definition of qualified real property eligible for expensing to include certain improvements to nonresidential real property place in service after the date such property was first placed in service. The improvements include roofs, heating, ventilation, and air-conditioning property, fire protection and alarm systems and security systems. This change not only allows a direct deduction for such improvements that are often encountered several times during the life of a building and that frequently generated controversy. Qualified improvement property continues to include certain leasehold improvement property, retail improvement property, and restaurant improvements and buildings. As under prior law, qualified improvement property is an improvement on the interior of a building. Modifications that enlarge the building do not qualify. The new law repeals the requirement that the improvement qualifies only if placed in service more than three years after the building is placed in service.
Property Used in Connection with Lodging The provision also expands the definition of Section 179 property to include certain depreciable tangible personal property used predominantly to furnish lodging or in connection with the furnishing of lodging. In the past longer-term lodging as an apartment was distinguished from lodging such as a hotel, motel, inn, etc. Property used predominantly to furnish lodging or in connection with the furnishing of lodging generally includes beds and other furniture, refrigerators, ranges, and other equipment used in the living quarters of a lodging facility such as an apartment house, dormitory, or any other facility where sleeping accommodations are provided.
Sport Utility Vehicle Limitation The new law changes the rule with respect to the the $25,000 limitation on sport untility vehicles such that this amount will be adjusted for inflation. The sport utility rule applies not only to the general definition of a sport utility vehicle but also a vehicle not subject to Section 280F and which is rated at not more than 14,000 pounds gross vehicle weight and has a seating capacity of less than 10 persons or truck with an interior cargo bed shorter than six feet.
Background For a number of years the law has contained a "bonus depreciation" provision the intent of which has generally been to increase capital investment. Under normal rules, the first years' depreciation is one-half of double the straight-line rate. The one-half is to account for the fact the property is in service for only a portion of the year. (Property placed in service in January gets 1/2 year of depreciation; so does property placed in service in December.) Bonus depreciation front loads the depreciation deduction even more. Under 50% bonus depreciation you can deduct half the asset's value in the first year, plus you can take the regular depreciation on the other half. That was the rule in effect prior to the new law.
New Law The new law allows 100% bonus depreciation rather than 50% on property placed in service after September 27, 2017 and before January 1, 2023. Bonus depreciation drops to 80% for property placed in service after December 31, 2022 and before January 1, 2024; 60% in the following year then 40% in the following year and 20% for property placed in service after December 31, 2025 and before January 1, 2027. No bonus depreciation is allowed for subsequent years. Property subject to a written binding contract for its acquisition entered into before September 28, 2017 does not qualify. The placed in service dates for property with a longer production period and noncommercial aircraft are extended by one year. Bonus depreciation applies to both new and used property. (Under prior law it only applied to new property.) Special rules apply to prevent abuse. They include:
Qualified leasehold improvement, restaurant property and qualified retail property retains a 15-year depreciation life, but now can be depreciated using MACRS (a faster method) rather than straight-line depreciation and the bonus depreciation rules apply.
The 100-percent bonus depreciation rules do not apply to assets used in a trade or business where the property has had floor plan financing indebtedness.
Bonus depreciation can be taken on qualified film, theatricial productions, or television shows placed in service after September 27, 2017.
Luxury Auto Limits Under Sec. 280F depreciation deductions for vehicles are capped on an annual basis. Under the old law it could take nine years to depreciate a $30,000 auto. The new law changes the limits for vehicles placed in service after December 31, 2017 and for which 100-percent bonus depreciation is taken. The new amounts are:
$10,000 for the first year,
$16,000 for the second year,
$9,600 for the third year,
$5,760 for the fourth and subsequent years.
These amounts will be adjusted annually for inflation.
Farm Assets The new law shortens the recovery period from 7 to 5 years for any machinery or equipment (other than any grain bin, cotton ginning asset, fence, or other land improvement) used in a farming business if the original use of the property commences with the taxpayer and is placed in service after December 31, 2017. The provision also repeals the required use of the 150-percent declining balance method for property used in a farming business (3-, 5-, 7-, and 10-year property only). The 150-percent method will continue to apply to 15- and 20-year property. A farming business electing out of the limitation on the deduction for interest (see later) must use the ADS method of depreciation any property with a recovery period of 10 years or more (e.g., single purpose agricultural or horticultural structures).
Computers Listed property is property of a type that could be used for recreational purposes such as autos, computers, cameras, audio equipment, etc. Computers used in an office environment aren't included, but those used at home are. In order to secure a deduction for listed property special recordkeeping requirements apply. That generally means keeping a log. Cellphones were removed from this list a number of years ago. The new law removes this computers and peripheral equipment from the definition of listed property (and the stricter substantiation requirements) effective for property placed in service after December 31, 2017.
Tax Tip--Being able to write off the full value of an asset in the first year will maximize cash flow for that year, but it could result in higher taxes down the road. You can elect out of the bonus depreciation for any class of asset for the year. If you do business as a pass-through entity (e.g., S corporation, LLC, partnership, etc.) the income or loss is passed through to the shareholders, partners, etc. and subject to the progressive tax rates. Moreover, you can generally no longer carry back losses to an earlier year. That means you could be getting a current deduction and saving taxes only to put yourself in a higher bracket in a subsequent year. There's no easy rule of thumb--you've got to work through the numbers. You should be looking at making an election if you're in a lower bracket and the depreciation deduction will be a substantial percentage of your before depreciation income. Talk to your tax advisor.
Tax Tip--Buy or lease? It's a frequent question when it comes to vehicles. Depreciation deductions are capped. Deductions for lease payments are restricted through the lease inclusion amount. But that restriction on lease payments appears to be less than those on depreciation under the old law. The new law may favor purchase and depreciation of an auto, at least for less expensive vehicles. While it's a point for consideration, the IRS has yet to release the lease inclusion tables for 2018 and there are other factors to take into account when leasing a vehicle for business purposes.
Tax Tip--While the new law removes the stringent recordkeeping requirements for computers, the IRS can still challenge the business use of any property. You should be able to show the computer is used regularly in your business. In many cases it's obvious. You're an independent salesman on the road and take and place orders with your office using the computer. That probably won't be questioned. On the other hand if you have a landscaping business and keep all your records using a paper ledger, you may want to be able to prove the business use in some way.
Copyright 2018 by A/N Group, Inc. This publication is designed to provide accurate and authoritative information in regard to the subject matter covered. It is distributed with the understanding that the publisher is not engaged in rendering legal, accounting, or other professional service. If legal advice or other expert assistance is required, the services of a competent professional should be sought. The information is not necessarily a complete summary of all materials on the subject. Copyright is not claimed on material from U.S. Government sources.--ISSN 1089-1536
--Last Update 02/09/18