Many new tax developments became effective at the start of 2016. This Alert highlights some of the more significant changes — particularly related to tangible property such as real estate and equipment and businesses engaged in research. For calendar year taxpayers, the provisions described below generally became effective on January 1. For fiscal year taxpayers, more specific details follow.
De Minimis Safe Harbor: Taxpayers are permitted to elect on an annual basis to deduct de minimis costs to acquire or produce tangible property. This allows taxpayers with applicable financial statements (e.g., statements that are audited by a CPA firm) to deduct certain costs of $5,000 or less per invoice or per item. For taxpayers without an applicable financial statement, the limit was $500 or less per invoice or per item in 2015.
Notice 2015-28 increased the de minimis safe harbor amount for taxpayers without an applicable financial statement to $2,500 or less per invoice or per item for 2016 and later taxable years. To take advantage of the increased safe harbor in 2016, taxpayers must adopt an accounting procedure as of the beginning of the taxable year to treat costs of $2,500 or less as an expense on the books and records for 2016. The adoption of the accounting procedure does not need to be in writing. For a taxpayer to use the higher $2,500 limit in 2016, the books and records need to consistently reflect the higher amount.
The higher safe harbor applies to taxable years beginning on or after January 1, 2016. That is, returns filed using the 2016 and later tax forms.
Bonus Depreciation: Before the enactment of the Protecting Americans from Tax Hikes Act of 2015 (PATH Act), the 50% bonus depreciation only applied to qualified property placed in service before January 1, 2015. The PATH Act generally extended bonus depreciation to property placed in service before January 1, 2020. However, the bonus amount is reduced for property placed in service in 2018 and 2019 to 40% and 30%, respectively.
For property placed in service before January 1, 2016, bonus depreciation applied to qualified leasehold improvement property. For property placed in service on or after January 1, 2016, bonus depreciation applies to qualified improvement property. As a result, there is no longer a requirement that the improved property be occupied exclusively by a tenant and that the tenant be an unrelated person. This change will allow taxpayers that use the improved property themselves to benefit from bonus depreciation. In addition, taxpayers that improve property in the hopes of attracting a tenant will now be able to benefit from bonus depreciation, as prior law required the improvement to have been made pursuant to a lease.
Improvements to nonresidential real property will qualify for bonus depreciation as qualified improvement property if the taxpayer or a tenant, including a related person, is the original user of the improvement. As with qualified leasehold improvement property, only improvements to the interior portion of a building qualify as qualified improvement property. The improvement must be placed in service after the date the building was first placed in service. This is a reduction from the three-year waiting period that applies to qualified leasehold improvement property, but appears to exclude improvements placed in service concurrently with the construction of the original building.
Certain improvements will not meet the requirements of qualified improvement property. Expenditures will not qualify if they are attributed to:
Expenditures attributable to any structural component benefiting a common area can be treated as qualified improvement property. This is a change from the treatment under the qualified leasehold improvement rules. Improvements to residential property are excluded from qualified improvement property, as well as qualified leasehold improvement property.
Taxpayers will generally depreciate the portion of qualified improvement property that does not qualify for the 50% (or smaller percentage) bonus depreciation allowance on a straight-line basis over 39 years. However, for property that also meets the requirement for qualified leasehold improvement property (for which the requirements have not changed), the excess is depreciated in a straight-line over 15 years.
It should be noted that tax-exempt use property does not qualify for bonus depreciation even if the property meets the requirements for qualified leasehold improvement property or qualified improvement property. Nonresidential real property is considered tax-exempt use property if it is leased to a tax-exempt entity under a disqualified lease - a lease term in excess of 20 years or under a sale-leaseback.
It should be further noted that bonus and qualified leasehold improvement depreciation potentially apply only if an expenditure with respect to tangible property must be capitalized under the tangible property regulations.
Section 179 Deduction Election: Taxpayers are permitted to elect to deduct - instead of capitalizing and depreciating - certain costs of tangible property subject to various limitations. Before the PATH Act, the costs of air conditioning and heating units could not qualify for the election to deduct costs. The Act allows a deduction for air conditioning and heating units for property placed in service in taxable years beginning after December 31, 2015. That is, returns that are filed using the 2016 and later tax forms.
Before the PATH Act, Section 179 deductions only applied to qualified real property that was placed in service before 2015. The Act made the deduction for qualified real property costs permanent. Qualified real property includes qualified leasehold improvement property, qualified restaurant property, and qualified retail improvement property.
Prior to the PATH Act, the ability to deduct the costs of qualified real property was limited to $250,000 per taxable year. For 2016 and later taxable years, the $250,000 limit has been repealed. Instead, the general Section 179 limitation of $500,000 per taxable year (increased annually for inflation) will apply. The repeal of the special limitation on the costs of qualified real property applies to taxable years beginning after December 31, 2015. That is, returns that are filed using the 2016 tax forms and later.
Under certain circumstances, a taxpayer may be better off claiming Section 179 expensing rather than bonus depreciation due to considerations such as state non-conformity and the related tax treatment of modifications to the federal depreciation amount.
Research Credit: The PATH Act made the research credit permanent. It had been terminated on December 31, 2014.
For 2015 and earlier taxable years, the research credit was available to generally offset 75% of the regular income tax liability of the taxpayer. (or 100% of any tax attributable to the trade or business or entity that generated the credit, if lower). However, the credit was limited to 0 in taxable years in which the taxpayer was liable for alternative minimum tax (AMT) (or limited to the amount by which the regular tax exceeded the tentative minimum tax). This provision undercut the utility of the credit to many high-income individuals that invested in businesses that conduct significant amounts of research.
For 2016 and later taxable years, the limitation on the research credit is computed as if the AMT (and tentative minimum tax) for the taxable year is 0 if the research is conducted by a small business. For this purpose, an entity is considered to be conducting a small business if the average annual gross receipts for the prior three taxable years is $50,000,000 or less. With respect to partners in partnerships and shareholders in S corporations, to apply the special research credit limitation, the partner or shareholder must independently meet the average annual gross receipt limitation. This provision will allow taxpayers that are subject to the AMT rules to benefit from the research credit.
Also for 2016 and later taxable years, certain small start-up companies can elect to apply up to $250 thousand of the research credit against payroll taxes imposed on wage payments. A start-up company can take advantage of the payroll tax provision if gross receipts are less than $5,000,000 in the current year and were zero in the prior five taxable years.
The changes to the rules for benefiting from the research credit apply to taxable years beginning after December 31, 2015.
If you have questions about these or other provisions, contact your Berdon advisor. New York Real Estate Accountants