On December 18, 2015, President Obama signed the Protecting Americans from Tax Hikes (“PATH”) Act of 2015, Public Law No. 114-113. The PATH Act permanently extended the §179 small business expensing limitations and phase-out amounts of $500,000 and $2 million, respectively and made §179 elections revocable on amended returns. Additionally, the act permanently extended the special rules that allow expensing qualified real property (QRP) which includes; qualified leasehold improvement property, qualified restaurant property, and qualified retail improvement property.
Beginning in 2016, the expensing limits and phase-outs will be indexed for inflation and the $250,000 cap on expensing qualified real property will be eliminated. The PATH Act also removed the restriction on expensing heating and air-conditioning units. Some may interpret this as meaning that all HVAC units may now qualify for §179, but this is not the case. Those that are either tangible personal property or QRP will qualify while most will remain as 39-year §1250 real property, and will not qualify. With all these changes, now is a good time to review the opportunities to use §179 expensing in conjunction with cost segregation studies. Before looking at how cost segregation and §179 interact, it is important to understand the basics of how §179 works.
When trying to understand §179, there are three important parts: 1) the expensing limitation; 2) the phase-out amount; and, 3) the income limitation.
The expensing limitation is currently $500,000 per year but will be indexed for inflation beginning in 2016. For 2010 through 2015, there is a separate limitation of $250,000 for qualified real property, which counts towards the general $500,000 expensing limitation.
The phase-out applies if a taxpayer invests more than $2 million in §179 property. If so, the §179 deduction is reduced dollar-for-dollar, but not below zero. This is known as the phase-out amount and means that a taxpayer will not have a §179 deduction if it has invested more than $2.5 million in §179 property in a year.
Once a taxpayer has determined the available §179 deduction, it is further limited by the taxpayer’s income. Generally, the income limitation is the taxpayer’s net income, but does not include credits, tax-exempt income, the §179 deduction, shareholder compensation for S corporations or guaranteed payments to partners, and net operating loss deductions. Amounts disallowed under the income limitation are carried forward to later tax years. After looking at §179’s limitations, how it interacts with cost segregation will make more sense.
Cost Segregation and §179When a taxpayer has a cost segregation study, the results identify tangible personal property, short-life land improvements, and qualified real property. Both tangible personal property and qualified real property may qualify for the §179 deduction if they were acquired by purchase (including self-constructed assets). Unlike bonus depreciation, §179 can also apply to used assets. However, §179 is not allowed for non-corporate lessors unless the lessor constructs or manufactures the property or the lease meets certain, other requirements. Section 179 is also unavailable for investors in residential rental property who hold the property for the production of income. For acquired properties, the opportunities are limited to C corporations or where the stringent lease requirements are met.
Once the general requirements of §179 are met, taxpayers can use the expensing election to greatly enhance the results of a cost segregation study by immediately expensing some or all of the indentified tangible personal property or qualified real property. Unlike ordinary depreciation deductions, the §179 deductions cannot create a loss. Since these deductions cannot create a loss, but are carried over under the income limitation, §179 deductions can also be used to avoid suspended passive activity losses. This is due to the difference in how active businesses are identified for §179 purposes and for §469 purposes. For these reasons, the combination §179 and cost segregation can be a powerful tax-planning tool for small businesses.
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Keywords: cost segregation, PATH Act, Protecting Americans from Tax Hikes Act, Public Law No. 114-113, §179, Section 179D