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When 15-Year Depreciation for QIP Might be Better than 100% Bonus Depreciation

April 2, 2021

In 2020, Congress passed legislation that corrects a drafting error related to real estate qualified improvement property (QIP). The correction is part of the Coronavirus Aid, Relief, and Economic Security (CARES) Act. The correction retroactively allows real property owners to depreciate QIP faster than before, either 100% the year the QIP is placed in service or over a 15-year period. The 100% bonus depreciation might sound a lot better, but in some cases 15-year depreciation will provide more tax savings in the long run.

Background

QIP is defined as an improvement to an interior portion of a nonresidential building that’s placed in service after the date the building was first placed in service. However, QIP doesn’t include any expenditures attributable to:

• The enlargement of the building,
• Any elevator or escalator, or
• The building’s internal structural framework.

When drafting the Tax Cuts and Jobs Act (TCJA) in 2017, members of Congress made it clear that they intended to allow 100% first-year bonus depreciation for QIP placed in service in 2018 through 2022. Congress also intended to give you the option of claiming 15-year straight-line depreciation for QIP placed in service in 2018 and beyond.

Due to a drafting error, however, neither first-year bonus depreciation for QIP nor 15-year straight-line depreciation made it into the actual statutory language of the TCJA. The only way to fix the mistake was to make a so-called technical correction to the statutory language.

Error Fixed

Because the CARES Act made that correction, QIP is now included in the Internal Revenue Code’s definition of 15-year property. In other words, it can be depreciated over 15 years for federal income tax purposes.

In turn, that classification makes QIP eligible for first-year bonus depreciation. So, real estate owners can now claim 100% first-year bonus depreciation for QIP placed in service in 2018 through 2022.

The technical correction has a retroactive effect for QIP that was placed in service in 2018 and 2019. Before the correction, QIP placed in service in those years generally had to be treated as nonresidential real property and depreciated over 39 years using the straight-line method.

15-Year vs. Bonus Depreciation

Claiming 100% first-year bonus depreciation for QIP expenditures makes sense if your primary objective is to minimize taxable income for the year the QIP is placed in service. But should that be your primary objective? Here are three reasons you might choose to depreciate QIP over 15 years, rather than claim 100% first-year bonus depreciation:

1. You may qualify for a lower tax rate on any gain from depreciation. When you sell property for which you’ve claimed 100% bonus depreciation for QIP expenditures, any taxable gain up to the amount of the bonus depreciation is treated as higher-taxed ordinary income rather than lower-taxed long-term capital gain. Under the current federal income tax regime, ordinary income recognized by an individual taxpayer can be taxed at rates as high as 37%.

In contrast, if you depreciate QIP over 15 years using the straight-line method, the current maximum individual federal rate on long-term gain attributable to that depreciation is “only” 25%. The gain is so-called “unrecaptured Section 1250 gain,” which is basically a special category of long-term capital gain. Higher income individuals may also owe the 3.8% net investment income tax on both ordinary income gain and long-term gain attributable to real estate depreciation.

The point is, claiming 100% bonus depreciation for QIP expenditures on a property can cause a higher tax rate on part of your gain when you eventually sell the property. Of course, if you don’t anticipate selling for many years, this consideration is less important.

2. Depreciation deductions may be more valuable in future years. When you claim 100% first-year bonus depreciation for QIP expenditures, your depreciation deductions for future years are reduced by the bonus depreciation amount. If tax rates go up (or you end up in a higher tax bracket), you’ve effectively traded more valuable future-year depreciation write-offs for a less-valuable first-year bonus depreciation write-off. Of course, there’s no certainty about where future tax rates are headed.

3. Claiming 100% bonus depreciation may lower your deduction for qualified business income (QBI) from a pass-through entity. Under the Section 199 deduction, sole proprietors and individual taxpayers who own pass-through entities, such as partnerships, S corporations, and limited liability companies treated as sole proprietorships, partnerships or S corporations for tax purposes, can claim a federal income tax deduction for up to 20% of QBI from the business activity. However, the Sec. 199 deduction from an activity can’t exceed 20% of net income from that activity for the year, calculated before the Sec. 199 deduction.

Net income from the activity of renting out nonresidential property will usually count as QBI. But claiming 100% first-year bonus depreciation for QIP expenditures for the property will lower the net income and potentially result in a lower Sec. 199 deduction.

In addition, the Sec. 199 deduction for a year can’t exceed 20% of your taxable income for that year, calculated before the Sec. 199 deduction and before any net capital gain (net long-term capital gains in excess of net short-term capital losses plus qualified dividends). So, moves that reduce your taxable income — such as claiming 100% bonus depreciation for QIP expenditures — can potentially have the adverse side effect of reducing your allowable Sec. 199 deduction.

The Sec. 199 deduction may be a use-it-or-lose it proposition, because it’s scheduled to expire after 2025. And it could disappear sooner, depending on political developments. If you forgo claiming bonus depreciation, your Sec. 199 deduction may be higher — and the foregone depreciation isn’t lost. You’ll just deduct it in later years when write-offs also might be more valuable because tax rates are higher.

Amended Return Opportunity

It’s also important to keep in mind that the CARES Act’s technical correction retroactively affects how you can depreciate QIP that was placed in service in 2018 and 2019. So, you may benefit from amending your 2018 or 2019 federal income tax returns already filed. Contact your tax advisor to determine the right course of action based on your situation.

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Business Provisions of the American Rescue Plan Act

March 18, 2021

On March 11th, President Biden signed into law the American Rescue Plan Act. This new law provides more than $50 billion in additional relief to small businesses. Detailed below are some of the highlights of the new law.

PPP

The bill includes $7.25 billion more for the Paycheck Protection Program; however, the bill did not extend the current application period which is currently scheduled to close on March 31st.

The bill also expands not-for-profits eligibility for the PPP with the new category called “additional covered nonprofit entity,” which are those not-for-profits listed in Sec. 501(c) of the Internal Revenue Code other than 501(c)(3), 501(c)(4), 501(c)(6), or 501(c)(19) organizations, that can receive an initial PPP loan, provided that:

-No more than 15% of receipts from lobbying activities.

-Lobbying expenses did not exceed $1 million during the most recent tax year that ended prior to Feb. 15, 2020.

-The organization has no more than 300 employees.

-Additional limits apply to eligibility of 501(c)(7) organizations.

Also made eligible for the PPP are some larger not-for-profits.

-Larger 501(c)(3) organizations and veterans’ organizations that employ no more than 500 employees per physical location.

-Larger 501(c)(6) organizations, domestic marketing organizations, and additional covered not-for-profit entities that employ not more than 300 employees per physical location.

EIDL

$15 billion for targeted Economic Injury Disaster Loan (EIDL) advance payments.

-Funds to businesses located in low-income communities with no more than 300 employees and have suffered an economic loss of more than 30%, as determined by the amount that the entity’s gross receipts declined during an eight-week period, between March 2, 2020 and Dec. 31, 2021, relative to a comparable eight-week period immediately preceding March 2, 2020.

-Funds from Targeted EIDL Advances shall not be included in the gross income of the person who receives the grant and that no tax deductions will be denied, no tax attribute reduced, and no basis increase denied due to the exclusion of the grant funds from gross income for Federal tax purposes.

Restaurants

$25 billion for restaurants, bars, and other eligible providers of food and drink.

-Allows for grants equal to the pandemic-related revenue loss of the eligible entity, up to $10 million per entity, or $5 million per physical location. The grants are calculated by subtracting 2020 revenue from 2019 revenue. Entities are limited to 20 locations.

-$1.25 billion for shuttered venue operators.

-$175 million to create a “community navigator” pilot program to increase awareness of and participation in COVID-19 relief programs for business owners currently lacking access, with priority for businesses owned by socially and economically disadvantaged individuals, women, and veterans.

Agriculture

Provides $4 billion to the U.S. Department of Agriculture (USDA), of which:

-$3.6 billion is dedicated to supporting the food supply chain, including purchasing food and agricultural commodities; making grants and loans for small to mid-size processors; seafood processing facilities; farmers markets, producers and other organizations responding to COVID; providing assistance to maintain and improve food and agricultural supply chain resiliency; and making payments for expenses related to crop losses pursuant to the Wildfire Hurricane Indemnity Program Plus.

-$300 million for surveillance and monitoring of animals susceptible to COVID-19 transmission.

-$100 million to reduce the amount of overtime meat, poultry and egg inspection costs at small establishments.

-$1.01 billion is dedicated for grants and loans to improve land access for socially disadvantaged farmers, ranchers, and forest landowners, in addition to scholarships, outreach, financial training, and other technical assistance.

-$800 million is provided to use the Commodity Credit Corporation to make purchases and distributions under the Food for Peace Program.

-Appropriates funds as may be necessary for loan modifications and payments to farmers and ranchers, who are members of groups that have been socially disadvantaged in the USDA programs. The department could pay as much as 120% of each such farmer’s or rancher’s debt on loans it made or guaranteed.

Employee Retention Credit (“ERC”)

The availability of ERC has been extended through December 31, 2021. Eligible employers have had operations fully or partially suspended as a result of government orders that impose limitations upon travel, commerce or group meetings due to COVID-19. Or employers that had a decline of more than 20% quarterly gross receipts compared to the same quarter of 2019 gross receipts.

-For 2021 qualified employers can take a 70% payroll tax credit on up to $10,000 qualified wages per employee per quarter for a maximum annual credit of $28,000 per employee.

-For 2021 employers with over 500 full-time employees qualified wages are only those wages paid to an employee on account of services not being performed. Employers with under 500 full-time employees qualified wages are those wages paid to employees whether or not the employees are providing services.

-The changes below only impact the 3rd and 4th quarter of 2021:

-New Recovery Startup Business expands eligibility to employers that began carrying on a trade or business after February 15, 2020, with annual gross receipts of up to $1 million that doesn’t otherwise meet the ERC eligibility. The credit is capped at $50,000 per quarter for recovery startup businesses.

-New severely financially distressed employers are those employers that experienced a decline in gross receipts of more than 90% compared to the same quarter in 2019. Severely financially distressed employers may treat all wages paid to employees as qualified wages regardless of the number of full-time employees.

Federal Emergency Paid Sick and Family Leave Credits

The availability of the federal emergency paid sick and family leave credits are extended through September 30, 2021. Providing federal emergency paid sick and family leave is voluntary by the employer and not required.

-The amount of eligible leave restarts on April 1, 2021.

-Employers can provide up to 10 days of sick leave from April 1, 2021 to September 30, 2021.

-COVID-19 testing without symptoms or if employer requests testing is eligible for paid sick leave up to $511 per day. Vaccine related leave is eligible for paid sick leave up to $511 per day.

– Federal emergency family leave credit is extended from 10 week to 12 weeks of paid leave between April 1, 2021 and September 30, 2021.

Child and Dependent Care Flex Benefit Plan

The amount that can be excluded from employee wages for employer-provided dependent care benefits is increased to $10,500 for married taxpayers and $5,250 for single taxpayers. This increase is for 2021 only.

 

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American Rescue Plan – Individuals

March 18, 2021

ECONOMIC IMPACT PAYMENTS

The American Rescue Plan provides for a third round of economic impact payments, commonly known as stimulus payments, of up to $1,400 per adult and any dependent. This time the earnings maximums are $80,000 for single filers, $120,000 for head of household and $160,000 for married filing jointly. For those with a direct deposit on file with the IRS payments should begin arriving immediately, those receiving checks should do so over the next several weeks.

UNEMPLOYMENT BENEFITS

The American Rescue Plan extends the federal unemployment insurance expansion through September 6,2021. The law maintains the federal supplement at its current level of $300 a week for weeks beginning after March 14th and before September 6th, 2021.

The Act also contains a provision that exempts the first $10,200 of unemployment benefits received in 2020 from income tax. The provision is retroactive and applies to benefits received in 2020. This provision only applies to individuals with income below $150,000.

EXPANDED CHILD TAX CREDIT

The American Rescue Plan expands the child tax credit and allows for taxpayers to receive the credit in advance of filing a return. The Act increases the credit to $3,600 for children under 6 and to $3,000 for children age 6 to 17. The Act also makes the credit fully refundable for 2021. The credit begins to phase out for taxpayers with incomes over $75,000 for single filers, $112,500 for head of household filers and $150,000 for married filing jointly filers.

Under the Act the IRS is directed to estimate a taxpayers’ child tax credit for 2021 and begin paying out one-twelfth of that amount monthly beginning in July. Meaning taxpayers receiving the full credit for a child under 6 would receive payments of $300 monthly. This advanced payment of the credit will need to be reconciled with the actual credit as part of the 2021 return process. The IRS has also been directed to set up an online portal to allow tax payers to opt out of the advanced credit or to provide additional information that may be relevant to modifying the amount that should be advanced.

 

 

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