New guidance clarifies depreciation and expensing of certain property
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On Dec. 21, 2018, the IRS released Revenue Procedure 2019-08, 2019-03 IRB 1 to address changes to the rules for expensing under Section 179 and depreciation under Section 168(g) after recent changes to tax laws (commonly referred to as the Tax Cuts and Jobs Act, or TCJA).
Updates for Section 179
TCJA modified the definition of “qualified real property” eligible for expensing under Section 179(d)(1). The Rev. Proc. clarifies the new definition and how to elect to expense qualified property under Section 179. Specifically, for property placed in service in taxable years after 2017, qualified real property includes qualified improvement property and certain other improvements to nonresidential real property. For qualified improvement property, the guidance notes that the definition of qualified improvement property in Section 168(e)(6) is the same as the definition in Section 168(k)(3) as in effect the day prior to the enactment of TCJA.
For property placed in service in a taxable year beginning in 2017 and ending in 2018, the guidance clarifies that qualified real property includes only property that qualified prior to TCJA (qualified leasehold improvement property, qualified restaurant property and qualified retail improvement property).
Taxpayers may elect to expense under Section 179 all or a portion of the cost of qualified real property placed in service by the taxpayer during any taxable year after 2017 by filing or amending a tax return. A taxpayer may increase the portion of qualified property expensed under Section 179 by amending its tax return for tax years after 2017. Such an amendment does not revoke any previously filed elections.
Updates for Section 168(g)
TCJA amended Section 168 by (i) requiring certain property held by an electing real property trade or business, as defined in Section 163(j)(7)(B), to be depreciated under the alternative depreciation system (ADS) in Section 168(g), and (ii) changing the recovery period under ADS from 40 to 30 years for residential rental property.
TCJA also amended Section 168 by requiring certain property held by an electing farming business, as defined in Section 163(j)(7)(C), to be depreciated under ADS.
Although TCJA changed the recovery period for residential rental property from 40 years to 30 years, Rev. Proc. 2019-08 clarifies that the 30-year recovery period is only for property originally placed into service after Dec. 31, 2017. The Rev. Proc. offers an optional depreciation table for residential rental property placed into service after Dec. 31, 2017 and depreciated using ADS with a straight-line method, 30-year recovery period, and mid-month convention. It is important to note that property converted to ADS will look to the original date placed in service, not the date of the conversion for determining the recovery period.
Rev. Proc. 2019-08 clarifies that an electing real property trade or business, or electing farming business, must begin using ADS depreciation for certain property in the year of the election. ADS applies not only to such property placed in service in the year of election and subsequent years, (newly-acquired property), but also to property placed in service in taxable years beginning before the election year (existing property).
For an electing real property trade or business, the requirement to use ADS applies to any nonresidential real property (as defined in Section 168(e)(2)(B)), residential rental property (as defined in Section 168(e)(2)(A)), and qualified improvement property (as defined in Section 168(e)(6)). For an electing farming business, any property with a recovery period of 10 years or more (as described in Section 168(c)) must use ADS.
For existing property, a change in use occurs in the election year as a result of the election. Depreciation for the election year is determined in accordance with Reg. Section 1.168(i)-4(d). The change in computing depreciation for the electing year of existing property is not considered a change in method of accounting under Section 446. Rev. Proc. 2019-08 emphasizes that bonus depreciation does not need to be redetermined if it was taken in the year the property was placed in service.
For newly-acquired property, ADS determines the depreciation from the date the property is placed in service. Note that property required to use ADS does not qualify for bonus depreciation.
If an electing real property trade or business or an electing farming business fails to apply ADS as required for two years, then such taxpayer has adopted an impermissible method of accounting. Revenue Procedure 2019-08 modifies Section 6.05 of Rev. Proc. 2018-31 to add procedures for obtaining automatic consent to change the method of accounting for depreciation due to a change in use for existing property. New Section 6.05(3) of Rev. Proc. 2018-31 states that a Section 481(a) adjustment should be calculated as though the taxpayer had used the correct method from the first day of the taxable year of the change in use.
Electing real property trades or businesses and farming businesses must use ADS for certain property, both previously existing and newly acquired. In the year of the election, the change in use rules apply to previously existing property. Thus, no accounting method change is needed to determine depreciation in the year of the election.
Check RSM’s Tax Reform Resource Center for the latest analysis on this and other developments related to tax reform.