How the TCJA Changes Depreciation Periods for Real Property
The Tax Cuts and Jobs Act (TCJA) alters the recovery periods for certain kinds of property depreciated under the modified accelerated cost recovery system (MACRS) and the alternative depreciation system (ADS). The law also expands eligibility for some additional depreciation deductions.
Nonresidential and residential properties
The TCJA leaves intact the recovery periods for nonresidential real property. They remain 39 years under the MACRS and 40 years under the ADS.
The MACRS period for apartment buildings and other residential rental buildings also is unchanged, at 27.5 years. The ADS period for these properties, however, is reduced to 30 years from 40 years for property placed in service after December 31, 2017.
Before the TCJA’s enactment, qualified leasehold improvement property (QLIP), qualified restaurant property (QRP) and qualified retail improvement property (QRIP) were depreciated over 15 years under the MACRS and over 39 years under the ADS.
The new tax law drops the separate definitions for QLIP, QRP and QRIP and classifies them all as qualified improvement property (QIP). That term under the TCJA generally covers any improvement to the interior of a nonresidential real property that’s placed in service after the building was placed in service. There are some exceptions, however.
For property placed in service after 2017, Congress intended for QIP to have a 15-year MACRS recovery period and a 20-year recovery under the ADS. Because 15-year property is eligible for bonus depreciation and Section 179 deductions, Congress intended for QIP to be eligible for both breaks.
However, due to a drafting error, the 15-year recovery period for QIP isn’t reflected in the statutory language of the TCJA. But it’s reflected in the Joint Explanatory Statement of Congressional Intent. Until technical corrections to these provisions become law, however, QIP has a 39-year MACRS recovery period, and it’s ineligible for bonus depreciation.
Interest expense deduction interplay
In addition, the TCJA generally limits business interest expense deductions to the sum of business interest income for the taxable year and 30% of the taxpayer’s adjusted taxable income for the tax year. The limit applies to taxpayers with average annual gross receipts over $25 million. Real estate businesses with annual receipts beyond that threshold can opt out of the new rule — but there’s a catch.
Businesses that opt out must use the ADS for certain property (generally, real property with a recovery period of 10 or more years) used in the business, regardless of when the property was placed in service. Moreover, businesses that opt out can’t claim bonus depreciation for affected property, and the opt-out election is irrevocable.
The TCJA gives real estate businesses a lot to think about. Discuss the tax law changes to evaluate the right options for your real estate venture.