Fixed asset planning remains one of the most reliable ways to minimize current tax payments. As a general matter, restaurants and hotels welcome the ability to accelerate the deductions associated with capital expenditures. The U.S. federal tax law provides several opportunities to accelerate tax deductions related to capital expenditures while state laws vary. Some states follow the federal tax rules, however, many do not and have decoupled. For this article, we will focus on the federal considerations.  

Tax fixed asset planning provides for accelerated deductions through two mechanisms:

1) Bonus depreciation

2) Current (non-depreciation) deductions

Different types of fixed asset analyses will result in either bonus depreciation or current (non-depreciation) deductions.  The type of fixed asset analysis performed will depend on whether the property is new to you (i.e., a space you just moved into and/or built out, or a property you constructed), or whether it is a space you have occupied for some period of time and are now remodeling or repairing. 

The following discussion is divided into two sections:

1) Opportunities to recognize bonus depreciation

2) Opportunities to recognize current (non-depreciation) deductions

Opportunities to recognize bonus depreciation

What is bonus depreciation and which asset groups does it apply to? Building property is generally depreciated ratably over the property’s recovery period. Non-building assets – such as furniture, fixtures and equipment – with shorter tax recovery periods are depreciated over their recovery period in a somewhat accelerated fashion. For eligible assets – which are typically short lived (non-building) assets – bonus depreciation allows a taxpayer to recognize additional first year depreciation. Bonus depreciation percentages have varied over time. Recently (for the past several years until 2023), taxpayers could recognize (depreciate currently) 100% of a qualified asset’s cost in the year of acquisition. Starting in 2023, however, the bonus depreciation percentage is reduced by 20% each year until it is completely phased out in 2027.

Bonus depreciation phase out

The Tax Cuts and Jobs Act (TCJA) brought about several changes to the additional first-year depreciation deduction, also known as bonus depreciation, outlined in Section 168(k). These changes include the expanded eligibility of both original-use and "used" property, as well as an increased bonus rate of 100% for eligible property placed in service between Sept. 27, 2017, and Jan. 1, 2023. It is important to note that time is running out to fully benefit from this provision, as the bonus percentage will gradually decrease by 20% each year until it phases out completely.

Below is a breakdown of the bonus depreciation rates based on the date the property is placed in service:

Cost segregation study

Although a familiar concept to many, a cost segregation study continues to be a powerful tax strategy that can immediately lead to increased cash flows and reduced tax liabilities. A cost segregation study analyzes in detail an organization’s fixed asset tax basis. The goal of the analysis is to identify assets that are currently being treated as 39-year real property and reclassifying those eligible assets into the most optimal asset lives allowable under the Internal Revenue Code. By reclassifying eligible assets into modified accelerated cost recovery system (MACRS) classes that carry shorter tax lives, taxpayers receive the benefit of accelerated (and potentially bonus) tax depreciation into earlier years.

One of the most appealing aspects of a cost segregation study is its applicability to a wide variety of taxpayers. The analysis can benefit organizations in almost any industry sector. Although certain types of facilities, such as restaurants and manufacturers, tend to yield greater results than others, companies with office buildings, warehouses, hotels, apartment complexes, and various real estate holdings should not be overlooked. Additionally, taxpayers can analyze costs associated with numerous activities, including:

• The acquisition of a facility
• Ground-up construction projects
• Expansions
• Tenant improvements
• Renovations
• Remodeling efforts

Qualified improvement property

Prior to the issuance of the Tax Cuts and Jobs Act (TCJA), P.L. 115-97, in 2017, separate property classifications existed for qualified leasehold improvements, qualified restaurant property, and qualified retail improvement property. However, the issuance of TCJA replaced the categories with a single, newly created classification known as qualified improvement property (QIP).

Qualified improvement property is any improvement made by the taxpayer 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 place in service, according to IRC Section 168(e)(6)(A). Furthermore, IRC Section 168(e)(6)(B) clarifies that QIP does not include any improvement made for the enlargement of a building, any elevator or escalator, or any internal structural framework of a building. Additionally, in order to be classified as QIP, the improvement must be made by the taxpayer, it must be placed in service after Dec. 31, 2017, and it must be Section 1250 property, according to Treas. Reg. section 1.168(b)(1)(a)(5). If an asset is classified as QIP, it is depreciated using the straight-line method, and using half-year convention (assuming mid-quarter does not apply) over a 15-year recovery period. QIP is generally eligible for bonus depreciation, however, the availability of bonus depreciation for state income tax purposes varies from state to state.

Additional tax planning options for taxpayers

Given the fact that the bonus depreciation percentages will go down over the next few years, and the fact that many states do not follow the federal bonus depreciation rules, it is always a good idea to consider additional tax fixed asset planning ideas that can help maximize current deductions such as the following.

1) Taking advantage of the Section 179 Expense Rule

As the phase-out of bonus depreciation approaches, certain small business taxpayers may still be able to take advantage of the Section 179 Expense rule. Under Code Section 179, taxpayers have the option to expense a specified amount of new or used qualifying property, known as "section 179 property," in the tax year it is placed in service. The ability to use section 179 is potentially limited because (1) there is a maximum amount that can be deducted under Section 179 in a given year; (2) there is a reduction to the 179 deduction limit based on how much Section 179 property is placed in service in a given year; and (3) most types of real property are not eligible for Section 179. 

2) Placed in service date acceleration

To qualify for any of these bonus depreciation percentages, it is crucial to try to ensure that the assets are placed into service before the specified deadline (see above for reduction in bonus depreciation percentages). Therefore, businesses considering significant acquisitions of fixed assets in the near future should recognize the critical importance of timing. Placing an asset into service in an earlier year will generally yield a higher bonus depreciation percentage (see chart above).

Opportunities to recognize current (non-depreciation) deductions

Consider a Tangible Property Regulation (TPR) analysis under Treas. Reg. Section 1.263(a)-3

Taxpayers who own or lease retail stores or restaurants frequently incur costs to maintain the appearance and/or functionality of the facilities. Treas. Reg. Section 1.263(a)-3(j)(3), Example Six, provides taxpayers with guidance on how to treat such expenditures for tax purposes. Specifically, a taxpayer that owns or rents retail stores periodically incurs costs “consisting of cosmetic and layout changes to the store’s interiors and general repairs and maintenance to the store building to modernize the store buildings and reorganize the merchandise displays. The work to each store consists of replacing and reconfiguring display tables and racks to provide better exposure of the merchandise, making corresponding lighting relocations and flooring repairs, moving one wall to accommodate the reconfiguration of tables and racks, patching holes in walls, repainting the interior structure with a new color scheme to coordinate with new signage, replacing damaged ceiling tiles, cleaning and repairing wood flooring throughout the store building, and power washing building exteriors.” The example concludes that, based on the specific facts, the taxpayer was able to deduct these costs under Treas. Reg. Section 1.263(a)-3.

Each taxpayer’s facts are different. Retail stores and restaurants that update their existing spaces should consider performing a “TPR analysis” to determine whether the expenses are deductible or capitalizable. 

While the Tangible Property Regulations became effective in 2014 and are not new this year, it is crucial to reconsider them now.

• Look-back TPRs are making a comeback! Most taxpayers filed accounting method change for the 2014 or 2015 tax return in order to comply with the final Tangible Property Regulation. The favorable news is that for the majority of taxpayers who want to change the accounting method in accordance with the TPR, this can be accomplished through the automatic procedures rather than the non-automatic procedures.

What does CohnReznick think?

The technical nuances and legislative landscape surrounding fixed assets continues to change, providing areas of opportunity and risk for taxpayers. For example, a House bill (H.R. 3938 – Build It in America Act) currently in draft form would reinstate 100% bonus depreciation for eligible assets placed in service before Jan. 1, 2026, if approved. In light of the continued updates and complexities within this area, taxpayers must stay apprised of the latest guidance and exercise caution when tax planning for capital projects.

Contact

Travis Butler, Director, National Tax – Cost Segregation

312.508.5821

Tim Morrison, Manager, National Tax – Cost Segregation

646.601.7744

Mike Guisinger, Manager, National Tax – Cost Segregation

704.307.2418

Xiaofei Wang, Manager, National Tax – Cost Segregation

301.280.2757