How Did Tax Reform Change Accelerated Depreciation Rules?

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Written by Guest | June 26th, 2019
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Guest Post by Riley Adams

Tax reform came and went, and taxpayers have been left to understand the changes. Many benefited from the law and have seen lower tax bills this year as a result, all things being equal. Corporations greatly enjoyed the dramatic reduction in the statutory corporate income tax rate from 35 percent to 21 percent along with other important changes to accelerated depreciation. 

A tax benefit many have taken advantage of is the result of depreciation, or the gradual decrease in the value of investments over time.  Traditionally, companies invest in an asset, determine its expected useful life, and allocate depreciation expense equivalent to the loss in value across time.

Under the tax code, the IRS established a more rewarding accelerated depreciation system to induce companies to invest and expand their operations, thereby growing the economy. Or so the argument goes.

While there is much debate about the effectiveness of the Modified Accelerated Cost Recovery System (MACRS), many corporate managers have taken advantage of the tax benefits given to them nevertheless.

Despite the unclear evidence of whether accelerated depreciation truly increases investment in the long-run, it has provided companies with ample opportunity to use time value of money to their advantage. This is because corporations can use MACRS depreciation, bonus depreciation, and Section 179 deductions to accelerate their depreciation expense from a tax perspective. 

Doing so lowers their tax burden today when a dollar is worth more while increasing it in the future when it is worth less. In other words, the total taxes paid are the same but when they are paid differs. 

Tax reform made some changes to these rules which will be of interest to corporations for their tax planning. This post examines the impact seen on accelerated depreciation because of tax reform.

Bonus depreciation

The Tax Cuts and Jobs Act of 2017 (TCJA) made some major changes in the tax code for taxpayers involved in a trade or business. Of focus here is the change in treatment for depreciation expense and the accelerated expensing of investments.

The MACRS depreciation tables many have come to know and love remain intact and unaltered by tax reform. However, how other accelerated depreciation treatment has changed is of interest.

In 2002, President Bush and Congress passed a new accelerated depreciation provision called “bonus depreciation” into law. For a time, this allowed for 50 percent of the value paid for qualified property to be depreciated in the year placed in service.

Tax law provided for a sunset provision on bonus depreciation, but several extensions sought to continue the treatment and eventually step down the tax benefit. This would avoid a cliff dive for corporations and their tax planning efforts. The Tax Cuts and Jobs Act ramped this back up.

The new law allows “full expensing,” which is the ability for corporations to expense (write off) the entire cost of an investment in the year placed into service. The tax reform changes allow full expensing for only five years, which should entice businesses to accelerate investments they likely would have made later.

In effect, this pulls forward investment that corporations otherwise would have made.

Section 179 expense

Before TCJA, taxpayers had the option to expense qualified section 179 property up to an annual limit of $500,000. The caveat to this accelerated depreciation provision comes from having a dollar-for-dollar reductions for each dollar which exceeds $2 million. These limits adjust for inflation.

Prior to the change, TCJA section 179 property included most depreciable tangible personal property.  TCJA reclassified many of the categories eligible for taking this deduction to more general classifications.

For example, prior to TCJA, only buildings or other land improvements which qualified for section 179 expensing included restaurant buildings and certain building improvements to leased space. In other words, leasehold improvements to prepare a rented space for better functionality.

Now, these restrictions have been removed and a broader qualified improvement property category has been put in place. Also included are certain structural components of a building like HVAC systems, fire protection and alarm systems, and security systems. The only requirement is that these improvements cannot relate to residential rental buildings.

The bottom line

Tax reform led to some changes in accelerated depreciation on certain fronts, while nothing much changed for MACRS depreciation. Bonus depreciation was expanded and extended to include full-expensing through 2022 while Section 179 generalized the property qualifications. 

The theory behind these tax provisions is to incentivize corporations into making added investment.  While uncertain of the effectiveness, many corporations use the benefits to their advantage and don’t look a gift horse in the mouth.

Riley Adams, CPA, is a senior financial analyst working for a Fortune 500 company in New Orleans, Louisiana.  He also runs the personal finance blog called Young and the Invested, a site dedicated to helping young professionals find financial independence and live their best lives.

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