A new 'PATH' for the Section 179 deduction
By Brett Aamot, CPA, Conway Deuth & Schmiesing, PLLP
October 3, 2016
In December 2015, President Obama signed the Protecting Americans from Tax Hikes (PATH) Act. In doing so, significant changes and enhancements were made to the Section 179 income tax deduction, some of which were anticipated by the tax and accounting community, while others were not. Many CPAs and accountants are still unaware of some of the more significant modifications affecting Section 179.
This article explains and expounds on several important developments resulting from the PATH Act, and offers some helpful tips related to Section 179 as you embark on year-end tax planning for your clients and businesses.
Extending the spending cap
As expected, the PATH Act extended the Section 179 spending cap for purchases of qualifying property and the expensing limits. Both were reinstated to their tax year 2014 limits of $2 million for eligible purchases and $500,000 for the expensing limit. In addition, Congress decided to make these Section 179 limits permanent, indexing for inflation in years beginning after Dec. 31, 2015. So, no longer will we be forced to wait until the middle of December every year for Congress to retroactively extend the Section 179 deduction. We now have an opportunity to effectively tax plan each year with reliable Section 179 rules.
In a surprising move, Congress extended the Section 179 eligibility for qualified leasehold improvements, and also enhanced Section 179 eligibility for qualified restaurant property and qualified retail improvement property. All of these changes were retroactively applied to the tax year 2015 and were permanently extended.
Buyer beware
It is important that tax professionals and accountants also understand potentially detrimental future tax consequences of taking accelerated depreciation -- such as Section 179 -- so that you can communicate these issues to business owners. Oftentimes, Section 179 is viewed as a tactic to reduce tax liability for the current year, without considering that you are really deferring taxes to a subsequent year, essentially "kicking the can down the road."
An example of the possibly unfavorable ramifications of accelerated depreciation is found currently in the agricultural industry. Many farmers are facing difficult times this year with commodity prices decreasing and costs increasing after experiencing record yields and profits in previous years. In order to make ends meet, they are liquidating property and equipment to cover debts and pay their expenses. In doing so, property that has been fully or partially depreciated under accelerated depreciation rules is sold, leaving producers exposed to significant tax gains at ordinary income tax rates.
In many cases, cash proceeds from the sale of property are used to pay bills, without regard for additional taxes incurred on the gain from a sale, leaving the taxpayer with significant unpaid taxes. If farmers and other business owners are prospectively made aware of this potential tax liability, they can make their business decisions accordingly. Section 179 should typically be used when it can provide a benefit through increased cash flow or tax savings, basically by shifting income into different periods. However, the tax consequences and potential liability from taking Section 179 need to be evaluated and defined.
Qualifications
To qualify for Section 179, leasehold improvements must be made pursuant to the lease, the portion of the improvement must be paid for and occupied exclusively by the lessee, and the improvement must be placed in service more than three years after the date the building was initially placed in service. Also, the improvements cannot include enlarging the building, adding an elevator or escalator, or any improvements to the common area, or to the internal structural framework of the building. Additionally, improvements made to real estate leased from a related party do not qualify for Section 179.
For restaurant property to qualify for Section 179, more than 50 percent of the building's square footage must be devoted to the preparation of meals or provide in-house seating for consumption of prepared meals. Qualified restaurant property would include any Section 1250 property that is a building or an improvement to a building.
For retail improvement property to qualify, the improvements must be made to the interior of a building, be open to the general public and be used in retail trade or business for the purpose of selling goods to the public. As with leasehold improvements, the retail property improvements must be placed in service more than three years after the date the building was initially placed in service.
A noteworthy enhancement increased the Section 179 deduction for qualified real property from its previous limit of $250,000 to $500,000 for the 2016 tax year and beyond. However -- as a cautionary observation -- remember that any accelerated depreciation on qualified real property will convert the gain on a sale of the property to ordinary income recapture, instead of a capital gain.
In another unexpected move, Congress extended Section 179 eligibility to air conditioning and heating units for tax years beginning after Dec. 31, 2015. Previously, air conditioning and heating units were an excluded property type for the Section 179 deduction. The PATH Act of 2015 has now removed the language excluding air conditioning and heating units from being eligible Section 179 property. And so, the following types of property now qualify for Section 179: portable air conditioning and heating units, whether for human comfort or business purposes; and, the portion of an HVAC system that is air conditioning or heating property used for a business purpose, or for human comfort.
The PATH Act also includes a permanent extension of Section 179 eligibility for computer software. To be allowed for Section 179, computer software must be off-the-shelf software, readily available for purchase by the general public, subject to a non-exclusive license and not substantially modified.
Other changes
To complement the Section 179 changes previously mentioned, the PATH Act permanently extends the ability for taxpayers to make, revoke or modify a Section 179 election without IRS consent on an amended tax return. This change is significant and will allow taxpayers flexibility with their Section 179 decisions moving forward.
Finally -- for year-end planning purposes -- we should all be aware of the following helpful reminders regarding Section 179:
Basic qualifications
- To qualify for Section 179, the property can be either new or used, and must be placed into service before the end of the tax year.
Certain assets do not qualify for Section 179
- Non-qualified real property, such as land, buildings, permanent structures and components of permanent structures (improvements)
- Paved parking areas and fences
- Property used outside of the United States
- Property acquired by gift or inheritance
- Any property acquired through certain IRS-defined related parties
Section 179 for vehicles
- Vehicles can be either new or used to qualify for Section 179.
- The business use of the vehicle must be at least 50 percent, and the depreciation limit is reduced by the percentage of personal use for the vehicle.
- Section 179 can only be claimed for the tax year in which the vehicle is purchased and placed in service. For instance, a vehicle initially purchased for personal use -- and converted to business use in a subsequent year -- does not qualify for the deduction. And, be aware of the differing Section 179 deductions available for the various classes of vehicles.
Section 179 for financed or leased assets
- Businesses can finance or lease assets and still take advantage of Section 179. Often, financing or capital leasing of assets can be a beneficial financial strategy while utilizing the Section 179 deduction, since the deduction could be significantly higher than the actual cash outlay during the first year.
Section 179 and state conformity
- Many states do not conform to the Federal tax rules related to Section 179. Since 2006, Minnesota has limited the amount of Section 179 that can be deducted on state tax returns. Be sure to review each state individually to understand the true tax consequences of Section 179.
With the recent changes made by the PATH Act of 2015, the Section 179 deduction has been significantly expanded and enhanced. It is imperative that we as CPAs and accountants stay abreast of these Section 179 changes so we can help make the best decisions for our clients and businesses.
Brett Aamot, CPA is managing partner at Conway, Deuth & Schmiesing, PLLP in Willmar. His practice specialties include business consulting, management advisory services, and auditing, tax preparation and planning for businesses. Brett also serves on the MNCPA board of directors.
