PATH Act Brings 50% Bonus Depreciation and 15 Year Lives to Common Commercial Real Estate Improvements

As a business person who deals or has dealt in commercial property, we wanted to inform you of new tax breaks under the Protecting Americans from Tax Hikes (PATH) Act.

As a general rule prior to PATH Act, the cost of commercial real estate improvements is recovered over 39 years through straight line depreciation. For 2016 and beyond, for a broadly defined category of realty improvements, taxpayers may be entitled to accelerated depreciation referred to as expensing under Code Section 179 of part of the cost of the improvements; 50% bonus first-year depreciation deductions of the portion of the cost that is not or cannot be expensed; and a shorter 15-year recovery period of the cost that is not expensed or recovered via bonus first-year depreciation.

For those improving commercial real estate, this is a significant tax change with material tax reduction benefits.

CODE SECTION 168(k) - FIRST YEAR 50% BONUS DEPRECIATION

While the definition of qualified leasehold improvement property is still included under the PATH Act, the act added a more expansive category called "Qualified Improvement Property".

Qualified improvement property is any improvement to an interior portion of a commercial building that is real property if the improvement is placed in service after the date the building was first placed in service.  Thus, it excludes improvements that are part of a new commercial building construction project.

Qualified improvement property does not include any improvement for which the expense is attributable to:

• The enlargement of the building;
• Any elevator or escalator; or
• The internal structural framework of the building.

Building improvements are now eligible for bonus depreciation regardless of whether the improvements are property subject to a lease and the improvement need not be placed in service more than three years after the date the building was first placed in service.

Phase down of bonus depreciation. For qualified improvement property placed in service before December 31, 2017, the bonus first-year depreciation is 50% of the cost.

The bonus first-year depreciation is 40%, for property placed in service in calendar year 2018 (or in calendar year 2019 for certain long-production-period property) and 30%, for property placed in service in calendar year 2019 (or in calendar year 2020 for certain long-production-period property). After December 31, 2019 bonus depreciation will not be available at all for qualified improvement property placed in service.

CODE SECTION 179 - EXPENSING:

Under the PATH Act, Code Section 179, up to $500,000 of expense per year, for up to $2,000,000 in Section 179 qualified additions was made permanent with an index for inflation.  So for 2016, the $500,000 expense remains the same, with the phaseout increased to $2,010,000.

Also under the PATH Act, special treatment for qualified real property elected to be treated as Section 179 property, was permanently extended and they removed the annual limitation of $250,000, increasing the annual limitation to $500,000.

Qualified real property is property that is classified as:

• Qualified leasehold improvement property, improvements that are made pursuant to a lease and occupied exclusively by the lessee;
• Qualified retail improvement property, property that is open to the general public and used in the retail trade or business selling tangible personal property; and
• Qualified restaurant property, property that is more than 50% of the building's square footage is dedicated to preparation of and seating for on-premises consumption of prepared meals.

In order to be qualified real property, the property must be depreciable, acquired by purchase for use in the active conduct of a trade or business, and must be used within the United States. In addition, the property cannot be owned by a related party and for the improvements to be eligible have to be on a building that was placed in service at least 3 years earlier.

Even with these expanded provisions of the PATH Act, in order to qualify for Section 179, the improvement still needs to meet the definition of qualified real property. Also not all businesses can qualify for section 179 expensing, either because the business has a loss or the improvements exceed the $2,010,000 threshold. This is where the first year bonus depreciation and the 15-year recovery period come into play.

As you may know, also new for 2016, as long as you have a capitalization policy in place, you can expense items up to $2,500 per item or per invoice.

If you have any questions regarding any of this information, please feel free to contact your tax planning expert at (603) 524-0507.

Date: 19 March 2016