Many taxpayers have had a chance to review their tax situation with their CPAs and understand many of the important provisions of the Tax Cuts and Jobs Act of 2017 (TCJA). Folks understand the lower tax rates, higher standard deduction and loss of personal exemption. But there are a few great tax changes for real estate investors.
The new tax breaks are especially important for commercial real estate owners. But residential owners will substantially benefit as well. These tax changes highlight the need for a cost segregation study to take advantage of many of the deductions.
New Tax Law: Bonus Depreciation
Bonus depreciation has been increased from 50% to 100% on certain qualifying assets. Real estate investors will receive immediate expensing of these items. Prior to TCJA, bonus depreciation was only allowed on original use property or property that was newly constructed.
TCJA also allows for used property that was acquired after Sept. 27, 2017 to qualify for this special treatment. A proper cost segregation study will break out any costs that qualify under the bonus depreciation rules.
Significance of In-Service Dates
In service dates are critical for newly constructed or acquired property. It is critical to understand when a valid contract was entered into between the specific parties. This is the case because pre September 27, 2017 contracts will not qualify for the100% bonus depreciation tax rate even when the property has an in service date after September 28, 2017.
Increased 179 Expense
Qualifying property under section 179 has now been extended to include roofing, HVAC systems, alarm systems, security systems and fire protection. In addition, for 2018 the amount of the annual deduction has been increased to $1 million with the phase-out deduction also being increased to $2.5 million.
These rules have been expanded to include certain tangible personal property that was acquired for rental properties, including appliances and furniture. This further highlights the need for a cost segregation study, even for residential rentals.
Pass-Through Deduction Under Section 199A
Pass through entities now can qualify for special tax treatment. Assuming they qualify, they can obtain a 20% deduction for 2018. This effectively drops the top marginal tax rate to 29.6% (80% x 37%). While each situation should be carefully examined, it might make more sense to take advantage of the deduction against the higher rate of 39.6% in 2017 (if that is possible). Your CPA or tax professional can help examine your situation.
New Tax Law: “Look-Back” Deductions
Cost segregation studies can even provide substantial tax savings for properties placed in service in prior years. Studies can be performed to “look-back” into prior years to identify certain assets that can qualify for a shorter life. The deduction for a prior look-back can often be taken on the subsequent filed tax return. Generally, you will not be required to amend any previously filed returns. Assuming you qualify, the IRS allows for a change of accounting method and it is reported on Form 3115.
Partial Asset Dispositions
When renovation work is performed, you can take a tax deduction for the remaining book value of items removed resulting from a renovation performed. A cost segregation study can assist in helping identify the original cost of the assets that have been removed, if not previously identified.
Tangible Property Regulations (TPR)
TPRs still are in place under tax reform. They can offer significant tax benefits when analyzing improvements that are made to buildings. The TPRs allow for the deductibility of certain renovation costs that can qualify as repair expenses.
In summary, tax reform has offered significant tax savings for real estate owners. Cost segregation studies are more relevant today than they were in the past. The ability to possibly reclassify renovations that were previously capitalized as a repair item can often be facilitated without the requirement of amending prior tax returns.