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A Primer on Depreciation Breaks for Commercial Real Estate

Commercial buildings and improvements are generally depreciated over 39 years.  Depreciation means that you can deduct a portion of the building and improvement cost every year over the building’s depreciation period (1/39 every year).   That may seem like a long time but there are special tax breaks that allow depreciation deductions to be taken more quickly for certain real estate investments. Some of these were enhanced by the Tax Cuts Jobs Act (TCJA) and may provide a bigger benefit when you file your 2018 tax return.  Due to a drafting error in the TCJA, there are two breaks you may not be able to take advantage of unless a technical correction is made to the TCJA.   (NOTE:  We will let you know when Congress passes a technical correction in the near future for this law oversight).

Section 179 – First Year Expensing

Section 179 expensing allows you to be able to deduct qualified improvement property right away rather than depreciating over a number of years. The TCJA also allows Sec. 179 expensing for certain depreciable tangible personal property used predominantly to furnish lodging and for the following improvements to nonresidential real property: roofs, HVAC equipment, fire protection, alarm and security systems. Starting in 2018, the Sec. 179 limit increases to $1 million (from $510,000 for 2017) on qualifying property. This is subject to a phase-out if your qualified asset purchases for the year exceed $2.5 million (compared to $2.03 million for 2017).

Shorter Recovery Period (39 year life to 15 year life) – Yes, No… Maybe?

This break historically allowed a shortened recovery period of 15 years for property that qualified. Before the TCJA, the break was available for qualified leasehold-improvement, restaurant and retail-improvement property. Again, the TCJA expanded the definition to “qualified improvement property.” But, due to a drafting error, no recovery period was given to such property, so it defaults to 39-year property. A technical correction must be issued (we believe a law change is almost a certainty) before you can claim accelerated depreciation for qualified improvement property.

Bonus depreciation

Qualified improvement property is not eligible for bonus depreciation due to the TCJA drafting error mentioned above. A technical correction will need to be issued in order to be eligible to use bonus depreciation on qualified improvement property. When available, bonus depreciation is increased to 100% (up from 50%) for qualified property placed in service after Sept. 27, 2017, but before Jan. 1, 2023. For 2023 through 2026, bonus depreciation is scheduled to be gradually reduced.

Warning: Under the TCJA, real estate businesses that elect to deduct 100% of their business interest expense will be ineligible for bonus depreciation starting in 2018.

Can you benefit?

Although the enhanced depreciation-related breaks may offer substantial savings on your 2018 tax bill, it’s possible they won’t prove beneficial over the long term. Taking these deductions now means forgoing tax deductions that could otherwise be taken later in later years.  In some situations — if your income will be in a higher tax bracket, for instance, or there is an increase in tax rates  — the normal depreciation deductions could actually be more valuable over a long-term basis.  We can help you evaluate when to maximize depreciation based on your specific facts and circumstances.

For more information on these breaks or advice on whether you should take advantage of them, please contact us at your convenience.

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