Accelerating Tax Deductions for Real Estate Review of Accelerated Depreciation and Repair Rules 2017 Schenck Real Estate Forum Ryan Sonnenberg, CPA Manager Depreciation In General Recover cost of asset over a statutorily defined recovery period (not related to useful life) Land Not depreciable (considered an appreciating asset) Building and its systems 39 years (straight-line) commercial real property 27.5 years (straight-line) residential real property Land and certain improvements 15 years (usually accelerated method) Carpeting, appliances and other fixtures 5, 7 years (accelerated method) 1
Bonus Depreciation/Section 179 Certain qualifying assets are eligible for bonus depreciation Deduct 50% of the cost ( bonus depreciation ) in year of acquisition Remaining 50% is recovered using normal depreciation method for the eligible asset Property with recovery period of 20 years or less Includes certain qualified real property Qualified Improvement Property New for property placed in service 1/1/2016 or later Use must begin with taxpayer Section 179 (election to immediately expense) eligible for certain types of qualified property ($500,000 limit) Qualified Real Estate Qualified Leasehold Improvement Property (QLIP) Bonus Depreciation: Yes Depreciation method: 15 year straight-line (after bonus) Any Improvement to an interior portion of a building which is nonresidential real property which are: Improvements made under/pursuant to lease by either the lessee or the lessor. Such portion will be occupied exclusively by the lessee and Such improvement is placed in service more than 3 years after the date building was first placed in service Does not include: The enlargement of a building Elevator/escalator Structural component benefitting a common area Internal structural framework Leases between related parties (more than 80% common ownership) Qualified Restaurant Property Bonus Depreciation: Only if the property qualifies as Qualified Improvement Property Depreciation method: 15 year straight-line (after bonus) Any 1250 property which is: A building Improvement to a building If more than 50% of the building s square footage is devoted to preparation of, and seating for on-premises consumption of, prepared food. Qualified Retail Improvement Property Qualified Improvement Property(QIP) (QRIP) Bonus Depreciation: Yes Bonus Depreciation: Yes Depreciation method: 15 year straight-line (after bonus) Any Improvement to an interior portion of a building which is nonresidential real property which are: Such portion is open to the general public and is used in the retail trade or business of selling tangible personal property to the general public Such improvement is placed in service more than 3 years after the date building was first placed in service Does not include: The enlargement of a building Elevator/escalator Structural component benefitting a common area Internal structural framework For property placed in services after January 1, 2016 Depreciation method: 39 year straight-line (after bonus) Any Improvement to an interior portion of a building which is nonresidential real property if such improvement is placed in service after the date such building was first placed in service. Does not include: The enlargement of a building Elevator/escalator Internal structural framework 2
Qualified Real Estate Part 2 Qualified Leasehold improvement Property (QLIP) Eligible for Section 179 2015 Tax Year: Yes, up to $250,000 as qualified real property 2016 Tax Year: No limit on real property; regular 179 limit applies Qualified Restaurant Property Eligible for Section 179 2015 Tax Year: Yes, up to $250,000 as qualified real property 2016 Tax Year: No limit on real property; regular 179 limit applies Qualified Retail improvement Property (QRIP) Eligible for Section 179 2015 Tax Year: Yes, up to $250,000 as qualified real property 2016 Tax Year: No limit on real property; regular 179 limit applies Qualified Improvement Property(QIP) Eligible for Section 179 No WI Treatment: 39 year Property WI Treatment: 39 year Property WI Treatment: 39 year Property WI Treatment: 39 year Property Repairs v. Capitalization When do we need to capitalize and Depreciate? No longer driven by dollar amount New repair rules effective for 2014 tax years Usually filed change in accounting for 2014 tax years to adopt the new rules IRS has extended the ability to adopt these rules through 2016 tax years No bright line test driven by facts and circumstances 3
Repairs v. Capitalization When the activity results in an improvement to a Unit of Property (UOP) the costs of this activity must be capitalized Improvements Betterment Make the UOP bigger, more efficient, higher quality, etc. Restoration Replacement of major component or substantial structural part Adaptation Change from originally intended use Unit of Property (UOP) Real Property Looks like one UOP but it s actually nine: eight building systems and then the building structure 1. HVAC systems 2. Plumbing systems 3. Electrical systems 4. All escalators 5. All elevators 6. Fire-protection and alarm systems 7. Security systems for building and occupants 8. Gas distribution system 9. Building structure excluding items 1-8 4
Summary of Conclusions from the 23 Betterment Examples Not a Betterment Replacement of asbestos insulation with similar non-asbestos insulation (Ex 2) Minor repairs and maintenance shortly after purchase (Ex 3, 4) Retail refresh limited to cosmetic and layout changes (Ex 6, 7) Relocate cash registers (Ex 9) Add concrete lining to meat plant (Ex 12) Roof membrane (Ex 13) Removal of drop ceiling (Ex 18) Replace 2 of 10 HVAC units that are 10% more efficient (Ex 20) Betterment Remediation of soil by previous owner (Ex 1) Bring assisting living building up to higher standards (Ex 5) Retail refresh along with increased storage, second loading dock (Ex 7) Major remodel of retail (Ex 8) Relocate machines increased capacity (Ex 10) Doubling depth of channel (Ex 15) 25% increase in depth of channel (Ex 17) 50% reduction in energy or power costs (Ex 21) Add restaurant drive through Summary of Conclusions from 31 Restoration Examples Not a Restoration Replace power switch (Ex 13) Roof membrane (Ex 15) Replace 1 of 3 furnaces in HVAC system (Ex 16) Replace 3 of 10 roof-mounted HVAC units (Ex 18) Replace 30% of electrical (Ex 21) Replace 8 of 20 sinks (Ex 23) Replace 100 of 300 exterior windows comprising 8.3% surface area (Ex 25) Replace lobby floors which comprise <10% square footage (Ex 28) Replace 1 of 4 elevators (Ex 30) Restoration Replace entire roof (Ex 14) Replace single chiller in HVAC (Ex 17) Replace of sprinkler system (Ex 19) Replace entire electrical system (Ex 20) Replace all toilets and sinks with similar quality and function (Ex 22) Replace 200 of 300 exterior windows comprising 16.67% surface (Ex 26) Replace 100 of 300 exterior windows comprising 30% of surface area (Ex 27) Replace floors in all public areas comprising 40% of sq. footage (Ex 29) Replace 1 of 4 elevators and claim partial disposition loss (Ex 31) 5
Summary of Change in Use Examples Not a Change in Use Combine 3 leased retail spaces into 1 leased retail space (Ex 2) Minor refresh of building in anticipation of sale (Ex 3) Clean up contamination after closing manufacturing plant (Ex 4) Convert a portion of grocery store space to a sushi bar (Ex 6) Convert a portion of hospital emergency room to an outpatient surgery center (Ex 7) Change in Use Convert manufacturing plant to showroom space (Ex 1) Regrade land to accommodate sale of land for residential development (Ex 4) Reconfigure part of a retail pharmacy to a walk-in clinic (Ex 5) De Minimis Safe Harbor (DMSH) Taxpayer allowed to deduct cost of assets less than a threshold amount regardless of whether it is a UOP or not Require a capitalization policy that is consistently followed for book purposes Threshold amounts $5,000 taxpayer with Applicable Financial Statements (AFS) $2,500 all others Determined on a per invoice/per item basis Annual statement included in return If election properly made IRS cannot question items deducted under DMSH 6
Partial Asset Disposition (PAD) Rule IRS figured out that you should only depreciate one asset as opposed to multiple assets at once New final regulations provide that the disposition rules apply to a partial disposition of an asset This rule allows taxpayers to claim a loss upon the disposition of a structural component of a building (such as a roof or a furnace) Regulations also allow a taxpayer to deduct the cost of removal, if proper method of accounting has been adopted Removal Costs Taxpayer is allowed to deduct the cost incurred to remove an asset Go in tandem with PADs need to elect PAD in order to deduct removal costs If haven t deducted removal costs, may need to file an accounting method change 7
Removal Costs Example Summaries Example 1 Removal costs incurred to replace original columns and girders supporting a second floor thereby permitting greater storage of supplies must be capitalized as a betterment because the taxpayer did not elect to treat the disposal of items as a partial disposition. Example 2 Same facts as Example 1, except the taxpayer elects to treat the disposal of the structural components as a disposition. In this case, the removal costs do not have to be capitalized, but the other costs of the betterment still must be capitalized. Example 3 Costs to remove old shingles and replace with new shingles do not have to be capitalized as long as the replacement of the shingles does not constitute an improvement to the building in this example, they are assumed to not improve the building because they were comparable to the original shingles. Example 4 Same facts as Example 3, except taxpayer elects to treat the replacement as a partial disposition. In this case, the new shingles must be capitalized. However, the cost of removing the old shingles does not have to be capitalized regardless of their relation to the improvement. Retail Refresh Safe harbor Safe harbor minimizes the need to perform detailed factual analysis to determine whether each remodel-refresh cost is for repair and maintenance or for an improvement 75% safe harbor for refresh expenditures with respect to certain retail and restaurant taxpayers (75% deduct, 25% capitalized GAA) Must have applicable financial statements (i.e., audited financials) Must be certain retail and restaurant or rent to certain retail and restaurant; depends on NAICS code Car dealers and other motor vehicle dealers excluded Hotel and motel businesses excluded Accounting method change can go back and get prior years if capitalized If took partial disposition, you must undo 8
To-do List Make sure you are taking advantage of qualified real property assets for depreciation purposes Have written capitalization policy Follow written capitalization policy It is for both book and tax Evaluate capital expenditures to ensure they are improvements Does PAD apply if I have replaced substantial structural component? Removal costs in conjunction with PAD to minimize amount of improvement that has to be capitalized Retail/Restaurant Refresh Safe Harbor THANK YOU! Ryan Sonnenberg, CPA Manager ryan.sonnenberg@schencksc.com 920-455-4150 800-676-0829 9
Transforming the Tax Code 2017 Schenck Real Estate Forum Corey Kolbe, CPA, CFP, MST Shareholder A Brief History Last major tax reform was 30 years ago Tax Reform Act of 1986 signed by Reagan Tax Code has tripled since 1986 Many believe the current Tax Code is overly complex and puts US businesses at a disadvantage in the current global economy GOP views this as a once-in-a-lifetime opportunity to overhaul the Tax Code 10
Current Status of Reform House introduced A Better Way tax plan June 2016 Crafted by Paul Ryan and Kevin Brady Introduced the concept of a border adjustment Trump s plan evolved during his campaign Both plans are similar in many ways but do have differences Overhauling the Tax Code is complex and will take time Main Objectives Cut corporate tax rates to the lowest since 1939 Put US businesses on par with foreign businesses Encourage investment in US manufacturing Cut individual rates to the lowest in 25 years Simplify both corporate and individual taxes 11
World Corporate Tax Rates Combined Corporate Rates 41% 39% 39% 39% 39% 39% 39% 39% 39% 39% 39% 39% 39% 39% 39% 37% 35% 33% 33% 32% 31% 31% 30% 29% 29% 28% 28% 27% 27% 26% 26% 26% 26% 26% 25% 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 United States OECD Average 12
Proposed Corporate Tax Changes Compressed and lower corporate rates Drop top rate from 35% to 15% (Trump) or 20% (House) Eliminate corporate Alternative Minimum Tax Allow most, if not all, capital expenditures to be deducted in the year of purchase Eliminate most business tax credits Research and development credit will continue Pass-Through Taxation Estimated that 95% percent of all US businesses are pass-through entities and sole proprietorships Account for 50% of US business income House plan creates a new entity level tax for pass-through business income Maximum 25% tax rate paid at the entity level Trump discussed an elective 15% entity level tax Distributions could be subject to second level of taxation at capital gains rates under Trump s plan Attempt to address reasonable compensation issue 13
Border Adjustment Transforming how businesses are taxed in the US Linchpin of the House A Better Way tax plan Trump appears to be on-board Currently a $500 billion trade deficit that is largely untaxed Dramatically shift US taxation from the current origin-based tax system to a destination-based tax system Border Adjustment Goals Encourage investment in US manufacturing Make US companies more competitive globally Stop corporate inversions Strengthen the US Dollar 14
Border Adjustment How Will the House Plan Work? Destination-based tax system taxes goods where they are consumed rather than produced Companies would no longer be able to deduct the cost of goods imported into the US Revenue from export sales would no longer be taxed in the US How Will the House Plan Work? A simple example Importer Exporter Current Law With Border Adjustment Current Law With Border Adjustment Sales 10,000 10,000 10,000 10,000 Cost of goods (5,000) - (5,000) (5,000) Labor (2,000) (2,000) (2,000) (2,000) Taxable profit 3,000 8,000 3,000 3,000 Corporate tax rate 35% 20% 35% 0% Tax 1,050 1,600 1,050 - Profit after tax 1,950 6,400 1,950 3,000 Less import costs - (5,000) - - True net profit after tax 1,950 1,400 1,950 3,000 15
Will it Become Law? Big US corporations have quickly picked sides and pushing hard for and against the border adjustment proposal Retailers, auto manufacturers and energy companies are against Boeing, GE, Merck, Pfizer, Eli Lilly, Dow Chemical are supporting GOP pushing the long-range benefit of strengthening the US Dollar A stronger Dollar will benefit importers $1 trillion in projected revenue over 10 years to offset tax cuts Capital Expenditures Trump plan would allow manufacturers to deduct all capital expenditures Non-manufacturers would have $1,000,000 Section 179 deduction House plan would allow businesses to deduct all capital expenditures personal and real property Only land would be capitalized Losses would carry forward Uncertain what income the losses could be used against 16
Interest Expense Deduction Trump would eliminate interest deduction for manufacturers Trade off for immediate expensing of all capital expenditures Companies may be given the option to capitalize assets and still claim the interest deduction House plan would limit the interest deduction to the amount of interest income for all businesses 1031 Tax Free Exchanges 1031 was enacted in 1921 to encourage reinvestment and make it easier for taxpayers to upgrade their assets Likely eliminated by tax reform Both Trump and House have proposed the complete elimination of 1031 tax free exchanges Will 1031 be unnecessary after tax reform? 17
Proposed Individual Changes Compress and lower tax rates From 7 brackets to 3 12%, 25% and 33% Trump and House are in agreement on the brackets Elimination of Alternative Minimum Tax Carried interest taxed at ordinary rates Above the line deduction for child care expenses Larger child tax credit to replace personal exemption Proposed Individual Rate Compression 18
Capital Gain Changes Trump has proposed no changes to capital gains taxation House would effectively tax all investment income at a maximum rate of 16.5% Interest, dividends and capital gains would qualify Taxed at ordinary income rates after a 50% exclusion Eliminate 3.8% net investment income tax Tax benefit of a capital gain would be reduced as the spread between ordinary and capital gains rates shrink Standard Deduction and Itemized Deductions Higher standard deduction Joint $12,700 to $30,000 Single $6,350 to $15,000 Trump would retain all current itemized deductions but apply a $200,000 cap House would eliminate the deductions for mortgage interest and taxes Less incentive for the average American to purchase a house 19
Proposed Estate Taxation Few pay an estate tax today Current exemption is $5,445,000 (effectively double to couples) Current tax rate is 40% 2015: 5,000 taxable estates generated $17 billion in taxes 1/3 of revenue was from 266 mega-estates Trump would eliminate estate taxes but at a cost Tax built-in, unrealized capital gains over $10 million at death Effectively cut the estate tax in half to 20% THANK YOU! Corey Kolbe, CPA, CFP, MST Shareholder corey.kolbe@schencksc.com 920-996-1132 800-236-2246 20