The Tax Cuts and Jobs Act (the “Act”), signed by President Trump on December 22, 2017, changed the manner in which taxpayers can approach the overall structure of their businesses. The Act includes multiple provisions that will afford taxpayers an opportunity to take advantage of generous depreciation rules that will ultimately decrease the costs of individual projects, as well as maximize the profitability of the overall business. For those in the construction sector, there are three important changes that are of particular interest: bonus depreciation, Section 179 deductions, and qualified improvement property.
In general, when a taxpayer purchases property, machines, equipment, or vehicles for use in a business, it is permitted to depreciate the asset over its useful life. Meaning that the costs, for tax purposes, is typically spread over a span of years. This general rule is accelerated when a taxpayer places “qualified property” into service. In the context of bonus depreciation, a taxpayer is entitled to fully deduct the costs of qualified property (short-lived assets with a useful life of 20 years or less) in the year the asset was placed into service.
For the first time in years, a taxpayer will be able to take full advantage of immediately deducting short-lived capital investments rather than requiring them to be depreciated over time. Prior to September 28, 2017, bonus depreciation was limited to 50 percent of new qualified property that was placed in service in any given year. Presently, bonus depreciation is no longer limited and was greatly expanded to include both new and used assets and qualified improvement property placed in service between September 28, 2017 and December 31, 2022 (or by December 31, 2023, for certain property with longer production periods). By allowing 100 percent bonus depreciation, a taxpayer is able to completely write off the cost of qualified property or qualified improvement property in the year it is placed in service. Historically, bonus depreciation has been limited to machinery, equipment, and software. Thus, any costs associated with replacing office furniture or HVAC units were not eligible for bonus depreciation. The Act removes some of the limitations to the definition of qualified property and adopts the classification of qualified improvement property as assets eligible for bonus depreciation. These changes help maximize profits by making tax breaks available for a broader range of new and used assets including computer systems, software, vehicles, machinery, equipment, office furniture, roofs, HVAC equipment, security systems, fire protection, and alarm systems.
Expanding the Maximum Section 179 Deduction
In addition to taking advantage of the Act’s bonus depreciation changes, taxpayers can increase write offs under Section 179. Section 179 deductions permit a taxpayer to write off the entire costs of qualified property (tangible property that is eligible for bonus depreciation, as well as computer software) in the year the qualified property is placed in service rather than recovering costs over several years. However, unlike bonus depreciation, the Section 179 deduction is limited to a taxpayer’s taxable income and it imposes a maximum deduction amount with a dollar-for-dollar phase-out. Prior to September 28, 2017, the maximum Section 179 deduction was $500,000, and there was a dollar-for-dollar phase-out for any taxpayer that placed more than $2,000,000 worth of Section 179 qualifying property into service during a single taxable year. Presently, the Section 179 deduction maximum of $500,000 has increased to $1,000,000 with the phase-out threshold also being increased from $2,000,000 to $2,500,000.
Under the Act, the increase of the maximum deduction amount allowable provides another incentive for a taxpayer to invest in the equipment, machinery, tools, technology, and other tangible property that are necessary for growth and to meet their strategic plans. Often, a taxpayer will combine the Section 179 deduction and the bonus depreciation, meaning a taxpayer could use the Section 179 deduction for the first $1,000,000 of equipment purchases and take bonus depreciation on equipment purchases between $1,000,000 and $2,500,000 to maximize the speed of recovery. There is, however, no single solution or approach and with the aggressive stance Congress has taken with both of these depreciation accelerators, it will be up to an individual taxpayer as to how each should utilize these opportunity to maximize value for their particular situations.
Qualified Improvement Property
For those in the construction industry who make eligible improvements to non-residential property, there is a third way to maximize profits under the Act. The expansion of improvements eligible for accelerated depreciation now mean all improvements to nonresidential property other than those that are attributable to internal structural framework (includes load-bearing walls/columns), enlarging a building, elevators, or escalators. These are narrow categories of what improvements will not be eligible qualified improvement property. Without any additional guidance, a taxpayer is afforded great flexibility with making improvements to nonresidential buildings. For example, accelerated depreciation is available to a taxpayer that removes permanent (not load-bearing) interior walls/columns and ceilings not needed for building stability and other structural components. These costs are not expansions or additions to the existing building. Nor are they changes made to a building’s internal structural framework. Thus, such expenses fall squarely within the definition of qualified improvement property. As the previous example shows, the new classification of qualified improvement property affords a taxpayer great flexibility with how to take advantage of shorter recovery periods to recover costs related to improvements made to nonresidential property.
Take Advantage of the Act to Maximize Profits
With an understanding of the basic concepts related to changes to the depreciation rules, now is the time to reassess how taxpayers structure their expenditures in construction projects. The Act creates new opportunities to pay fewer taxes on routine purchases and provides incentive for taxpayers to make investments that would otherwise be more costly under the old rules. Whether that involves installing new commercial fire sprinklers or repairing a roof, taxpayers in the construction industry should properly plan so expenditures fall within a framework that helps further the objectives of the business or project. Expenditure decisions should not be based solely on tax considerations of now generous depreciation rules. However, taxes, and the new changes in the law, are important business considerations when drawing the site plan for a business in 2018 and beyond.
With all of the changes to the tax landscape, now is the right time for our construction industry partners to re-evaluate how taxes and expenditures fit into their site plans for their businesses moving forward.