business that has floor plan financing indebtedness ; and 3 ) property used in a real property trade or business that makes an irrevocable election out of the interest expense deduction limitation under section 163 ( j ). Under the interest expensing provisions , these entities would have to depreciate residential real property , nonresidential real property and QIP under the ADS lives and methods . Therefore , such property would not be eligible for bonus depreciation .
Applicable Recovery Periods for Real Property The Act retained the current Modified Accelerated Cost Recovery System ( MACRS ) recovery periods of 39 and 27.5 years for nonresidential and residential rental property , respectively . However , the ADS recovery period for residential rental property was reduced to 30 years from 40 years effective for property placed in service on or after Jan . 1 , 2018 .
The Act eliminated the separate definitions of qualified leasehold improvement , qualified restaurant and qualified retail improvement property . Instead , the Act provides simplification with a general 15-year recovery period for QIP ( and 20-year ADS recovery period ). QIP 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 , excluding enlargements , elevators / escalators and internal structural framework . The improvements do not need to be made pursuant to a lease .
Electing Real Property Trades or Businesses
As noted above , a real property trade or business that elects out of the interest expense deduction limitation must use ADS to depreciate nonresidential real property ( 40 years ), residential rental property ( 30 years ) and QIP ( 20 years ). The modifications to the ADS recovery period for residential rental property ( 40 years to 30 years ) as well as the 20-year ADS recovery period for QIP ( versus 40-year under pre-Act law ) may provide an opportunity for certain taxpayers in real property trades or businesses to shorten their recovery periods while at the same time electing out of the interest limitation . An election out would require taxpayers to treat a change in the recovery period and method as a change in use ( if affecting property already placed in service for the year the election is made ).
Subsequent changes to the law ( section 202 of Taxpayer Certainty and Disaster Tax Relief Act of 2020 ) now allow for taxpayers with residential real property placed in service before Jan . 1 , 2018 , to file a “ change in use ” automatic change in accounting method to correct 40-year ADS life to 30-year ADS life . This automatic accounting method change will generally result in a catch-up depreciation deduction .
Expansion of Section 179 Expensing
The Act increased the maximum amount a taxpayer may expense under section 179 to $ 1 million with annual increases indexed for inflation . The current 2022 section 179 limit is $ 1.08 million . The investment limit ( also referred to as the total amount of equipment purchased or phase-out threshold ) was also increased to $ 2.5 million with the indexed 2022 limit is $ 2.7 million . The current $ 1.08 million limitation is reduced ( but not below zero ) by the amount by which the cost of qualifying property placed in service during the taxable year exceeds $ 2.7 million . Expect and review for annual inflation adjustments .
The TCJA also expanded the definition of section 179 property to include certain depreciable tangible personal property used predominately to furnish lodging or in connection with furnishing lodging ( i . e ., beds or furniture used in hotels and apartment buildings ). The definition of qualified real property for section 179 purposes was also expanded to include any of the following improvements made to nonresidential real property : roofs , exterior heating , ventilation and air-conditioning property , fire protection and alarm systems and security systems as long as the improvements are placed in service after the date the building was first placed in service .
Planning Considerations for Gym Owners These expensing and cost recovery rules may significantly change the analysis for cost recovery . Determining the appropriate tax treatment for tangible property expenditures may require a “ decision tree ” analysis beginning with identification of items that qualify for a current deduction under existing rules ( i . e ., repairs or incidental materials and supplies ), then identifying other exceptions and applying as appropriate .
Cost segregation studies . Consideration of a cost segregation study is now more important than ever . A cost segregation study is an in-depth analysis of the costs associated with the construction , acquisition or renovation of owned or leased buildings for proper tax classification and identification of assets that may be eligible for shorter tax recovery periods resulting in accelerated depreciation deductions .
The reclassification of assets from longer to shorter tax recovery periods also make these assets eligible for bonus depreciation resulting in even more substantial present value tax savings , especially with 100 % bonus depreciation for qualified property placed in service from Sept . 28 , 2017 , through the end of 2022 . Tangible personal property and land improvements identified in the cost segregations of acquired property placed in service after Sept . 27 , 2017 , are now qualified property for bonus depreciation purposes since the definition of qualified property was expanded to include used property .
Cost segregation is especially critical to real property trade or businesses that may not claim bonus depreciation on QIP because of the election out of the interest deduction limitation . These entities may desire the tax benefit from the reclassification of personal property to shorter tax recovery periods resulting in accelerated depreciation deductions . The modification to the recovery period under ADS ( to 30 years from 40 for property placed in service after Dec . 31 , 2017 ) for residential rental property , as well as the 20-year ADS recovery period for QIP , also provides these real estate taxpayers with the ability to recover real property over shorter recovery periods .
The IRS provides numerous automatic changes in accounting methods for missed opportunities to segregate bonus-eligible assets and claim a catch-up section 481 ( a ) deduction . These deductions can be significant with the filing of Form 3115 .
Taxpayers should balance the numerous options with their fixed asset additions , renovations and remodels . The repairs and maintenance regulations may provide deduction opportunities that both simplify reporting and deductions for states not complying with bonus depreciation . In cases where a 100 % bonus for QIP additions is the fact , there may be a second opportunity to take a partial asset disposal deduction on the abandoned assets replaced by the QIP . G
This article was authored by Baker Tilly , a leading advisory , tax and assurance firm that facilitates growth for Planet Fitness ® franchise operators throughout the United States . For any questions , please contact Andrew Chaves , partner at Baker Tilly , at Andrew . Chaves @ bakertilly . com .
GearedUp | 2023 Issue 3
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