Various tax law changes have drastically altered tax deductions in favor of property owners in recent years. In 2013, the final tangible property regulations were released, and in late 2017, the Tax Cuts and Jobs Act was passed, which added the qualified business income deduction (Section 199A). The deprecation deduction has become extremely favorable for the taxpayer, and property owners can now more easily reduce their taxable income through increased deductions.
The tangible property regulations determine capitalization and expensing of property. A good place to start in navigating these regulations is to determine whether the expenditure is a betterment, restoration, or adaptation. For example, a betterment or restoration would be something like a comprehensive remodeling or correcting a pre-existing defect. Things like this result in capitalization of the expenditure. If the expenditure does not fit this definition, then you’ll need to determine if it should be expensed under de minimis, or the small business safe-harbor election.
• De minimis allows the expensing of items under $2,500 (or under $5,000 if you have applicable financial statements) that would otherwise be capitalized. To make the election, you simply include a statement with the tax return citing the de minimis safe-harbor election.
• The small taxpayers safe-harbor election allows the write off of repairs, maintenance, and improvements if the average annual gross receipts from the preceding three years is $10 million or less, or if property units have an adjusted basis of $1 million or less. To make this election, you also must attach a statement citing the safe-harbor election for small taxpayers.
Regarding depreciation, tangible property placed in service after Sept. 27, 2017 is eligible for 100 percent depreciation if it has a useful life of 20 years or less. So, full expensing of qualified items results in large amounts of deductions for certain taxpayers.
Furthermore, Section 199A, which was enacted by the Tax Cuts and Jobs Act of 2017 and is also known as the qualified business income deduction, can only be utilized if certain requirements are met by landlords. The most important requirement is that the entity needs to qualify as a trade or business. To qualify, the real estate must be owned directly (or through a disregarded entity). Additionally, there must be separate books maintained for each rental enterprise, at least 250 hours of active rental services provided, and thorough records to prove without any doubt that the services have been rendered. If qualified, one could receive a deduction of up to 20 percent of the qualified business income. It should be noted that there are restrictions to this deduction based on various qualifications, which should be adequately evaluated prior to using.
Bottom line: are you taking advantage of the opportunities that the tax law is now providing? There are many available public resources, including the IRS website (https://www.irs.gov/newsroom/tax-cuts-and-jobs-act-provision-11011-section-199a-qualified-business-income-deduction-faqs) that can provide helpful information. Be sure to review these often and consult with a certified financial-services professional to be sure you are making the laws work for you.
Cheryl A. Prout is a partner and a member of the real estate industry team at The Bonadio Group accounting firm. Contact her at firstname.lastname@example.org. Connor Galvin is a member of Bonadio’s small business advisory team. He can be reached at email@example.com