As the first year allowance for bonus depreciation is scheduled to decrease to 80% for property placed in service during 2023, taxpayers are considering the timing of capital acquisitions to maximize their tax deductions.
2017’s Tax Cuts and Jobs act (“TCJA”) temporarily increased the first year deduction allowed for certain qualified property to 100% of the adjusted basis of assets placed into service after September 27, 2017 and before January 1, 2023. Qualified property includes various equipment, furniture and fixtures, as well as land improvement and qualified nonresidential building improvements (“QIP”). However, property depreciated under the Alternative Depreciation System (“ADS”) is not eligible for the first year allowance and must be depreciated over the life of the asset as provided in the tax code.
Taxpayers should consider the impact of the business interest limitation rules under section 163(j) which limit the interest expense deduction for applicable businesses to 30% of adjusted taxable income, with an optional opt-out election for real property trades or businesses. Real estate businesses electing out of the sec. 163(j) limitations must depreciate their real property, including QIP, under the ADS method (precluding the QIP assets from bonus depreciation). For taxable years beginning prior to December 31, 2021, depreciation and amortization deductions are excluded from the computation of adjusted taxable income for the purposes of Sec. 163(j). This allows certain real estate investors to forgo the opt out election and continue to take the first year allowance for 100% of their qualified improvement property.
For taxable years beginning in calendar year 2022, adjusted taxable income no longer excludes depreciation and amortization, which may result in additional real estate businesses making the election under 163(j) and no longer being able to utilize the 100% bonus write off in the year the QIP is placed into service.
The ADS requirements under Sec. 163(j) only apply to real property and QIP, not to land improvements and “personal” property under the tax code, such as furniture, fixtures and equipment. Therefore, it may be worthwhile to perform a cost segregation study to determine if newly acquired or renovated real property includes a substantial portion of shorter life property eligible for bonus depreciation.
Under current law, the applicable percentage of adjusted basis of qualified property allowed in the first year will be phased out as follows:
- For property placed into service between January 1, 2023 and December 31, 2023, 80%.
- For property placed into service between January 1, 2024 and December 31, 2024, 60%.
- For property placed into service between January 1, 2025 and December 31, 2025, 40%.
- For property placed into service between January 1, 2026 and December 31, 2026, 20%.
Qualified property must be acquired by the taxpayer and placed into service prior to January 1, 2027. Different rules apply to software, utility property, film and theatrical productions and certain assets having longer depreciable lives.