An Important Tax Planning Opportunity for Architectural/Engineering Firms
The Section 179 election provides A/E firms with an excellent tax planning opportunity to consider as year-end approaches. The election, which permits firms to completely expense the cost of qualifying fixed asset additions in the tax year in which they are purchased and placed in service, results in a dollar-for-dollar deduction against taxable income, subject to the taxable income limitation discussed below. Importantly, this expensing election may be taken whether the assets have been fully paid for by the end of the year or acquired with financing, thereby ensuring that the deduction from taxable income is received at least as fast as the cash outflow occurs, rather than being taken over the assets’ useful lives.
While the election to expense the cost of qualifying property under Internal Revenue Code (IRC) Section 179 isn’t a new concept, recent changes enacted under the Tax Cuts and Jobs Act (TCJA) , which was enacted on December 22, 2017, make Section 179 even more attractive as a tax planning opportunity for architectural and engineering firms for the 2018 tax year.
Pre-Tax Cuts & Jobs Act Law
Prior to enactment of the TCJA, the cost of qualifying property was eligible for expensing under IRC Section 179 for purchases during the 2017 tax year in an amount up to $510,000. The maximum expensing election was reduced, but not below zero, for qualifying property placed in service during the 2017 tax year in excess of a threshold amount of $2,030,000.
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Changes Under the Tax Cuts & Jobs Act
With the enactment of the TCJA, for tax years beginning after December 31, 2017, the amount of qualifying property placed in service during the tax year that may be expensed was increased to $1,000,000, with this amount to be indexed for inflation in subsequent tax years. Similarly, the threshold at which the expensing election is phased out was increased to $2.5 million, with inflation indexing in subsequent tax years. Furthermore, the Section 179 expensing election was made permanent under the TCJA.
The Section 179 expensing election is further limited by the taxable income derived from the active conduct of all of the trades or businesses that a taxpayer engaged in during the tax year. Amounts disallowed as a result of the taxable income limitation may be carried forward to future tax years.
Qualifying Property Under Section 179
Under both the pre-TCJA law and the recently enacted changes, qualifying property for purposes of the Section 179 expensing election includes depreciable tangible personal property, which is purchased by a taxpayer from an unrelated party for use in the active conduct of a trade or business. To maintain the use in an active trade or business requirement and avoid “recapture” of previously deducted amounts, the asset must be used more than 50% in the taxpayer’s trade or business.
In addition, off-the-shelf software which is purchased prior to year-end is eligible for the Section 179 expensing election. Off-the-shelf software is defined for this purpose as computer software that is readily available for purchase by the general public, is subject to a nonexclusive license and has not been substantially modified.
Certain real property and vehicles are also eligible for expensing under Section 179, as discussed in the sections below.
Qualified Real Property
Prior to the enactment of the TCJA, qualified property for purposes of the Section 179 expensing election included Qualified Leasehold Improvement Property, Qualified Restaurant Property and Qualified Retail Improvement Property. The TCJA compressed these three categories into what is now termed “Qualified Real Property,” which is defined as any improvement to an interior portion of a building which is nonresidential real property if such improvement is placed in service after the date the building was first placed in service. Qualified real property does not include any improvement for which the expenditure is attributable to the enlargement of the building, any elevator or escalator or the internal structural framework of the building.
The definition of Qualified Real Property for purposes of Section 179 was also expanded to include depreciable personal property used predominantly to furnish lodging or in connection with furnishing lodging. Similarly, the following improvements to nonresidential real property were added to Qualified Real Property as a result of the TCJA:
- Heating, ventilation and air conditioning property
- Fire protection and alarm systems
- Security systems
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Vehicles Used in a Trade or Business
As in prior years, passenger automobiles subject to the luxury auto limitations under IRC Section 280F are eligible for Section 179 expensing up to the annual Section 280F limitations. For vehicles placed in service during 2017 the depreciation limit for passenger automobiles for which bonus depreciation was not elected was $3,160 in the first year, $5,100 in the second year, $3,050 in the third year and $1,875 in the fourth and subsequent tax years. For vehicles placed in service during the 2018 tax year, this limitation is increased to $10,000 in the first year, $16,000 in the second year, $9,600 in the third year and $5,760 in the fourth and subsequent tax years.
For sport utility vehicles (SUVs) with a Gross Vehicle Weight Rating (GVWR) over 6,000 pounds but under 14,000 pounds, which are not subject to the Section 280F depreciation limitations, the maximum depreciation limit is $25,000, subject to indexing for inflation in future tax years. However, recent changes to bonus depreciation effectively negate this $25,000 limitation, provided the taxpayer doesn’t elect out of bonus depreciation.
Coordination with IRC Section 168(k) Bonus Depreciation
In conjunction with the expansion of the Section 179 expensing election, the Tax Cuts and Jobs Act also increased the IRC Section 168(k) bonus depreciation from the 40% deduction previously scheduled for the 2018 tax year to 100% for qualified assets placed in service after September 27, 2017 and before January 1, 2023. To qualify for bonus depreciation, property must be depreciable under IRC Section 168, with a recovery period of 20 years or less. For property placed in service after December 31, 2022 and before January 1, 2024, the bonus depreciation amount will be reduced to 80% and will continue to phase out over the following three tax years.
According to Congressional Committee Reports, Qualified Real Property will be treated as 15-year property eligible for the 100% bonus depreciation deduction. However, existing tax legislation does not permit this treatment, and a technical correction will therefore be required before bonus depreciation may be taken on Qualified Real Property.
In addition, vehicles to which the Section 280F luxury auto limitations apply are eligible for an additional $8,000 in first-year bonus depreciation. As mentioned above, for heavy SUVs to which the Section 280F annual depreciation limitations do not apply, the entire cost may be deducted in the year of purchase under the Section 168(k) 100% bonus depreciation provisions.
Under pre-TCJA law, the original use of the property was required to start with the taxpayer. In other words, used property was excluded from the definition of qualified property for purposes of bonus depreciation. The Tax Cuts and Jobs Act, however, removed this requirement, resulting in both new and used property being eligible for 100% bonus depreciation, provided the taxpayer did not previously use the property.
In determining whether to elect Section 179 or take the 100% bonus depreciation on qualified property, Architectural and Engineering firms will want to consider three differentiating features of these opportunities. First, bonus depreciation is not capped at a maximum of $1 million in fixed asset additions, subject to the phase-out for purchases in excess of $2.5 million. Second, and perhaps more importantly for most A/E firms, bonus depreciation is not subject to the taxable income limitation imposed by IRC Section 179. And finally, assets for which Section 179 expensing has been elected are not included in the mid-quarter convention testing, while assets for which bonus depreciation has been taken are. As a result, Section 179 can often be utilized to avoid (or force) the mid-quarter convention of depreciation on other assets placed in service during the tax year.
This article should help to illustrate some of the expanded provisions of the IRC Section 179 expensing election, as well as some of the distinguishing provisions of IRC Section 168(k) bonus depreciation to consider in your year-end tax planning activities. Please visit our website at www.dmcpas.com for more information about the tax services we offer. If you would like to discuss the Section 179 expensing election or any other tax matters pertaining to your A/E firm, feel free to reach out to me anytime!
About the Author
Deborah E. Finch, CPA/ABV, CVA, CDA is a tax partner with the Firm and has over thirteen years of experience in taxation and planning for individuals and closely held companies. Prior to joining Dannible & McKee, LLP, Debbie spent ten years in private industry. In addition to her work in the corporate and individual taxation and planning arena, Debbie is extensively involved in the Firm’s business valuation and litigation support practice. She works closely with Architectural/Engineering (A/E) firms and other closely held professional practices on the development of business valuation studies and structuring ownership transition plans.
Deborah E. Finch, CPA/ABV, CVA, CDA
Partner, Dannible &McKee, LLP
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