The Small Business Jobs Act broadened the expensing rules under Section 179 of the federal tax code, which traditionally apply only to depreciable personal property.
Now, for the first time ever―and only for 2010 and 2011―certain real property is eligible for Section 179 expensing. In general, the new expensing option applies to qualifying restaurant property, retail property, and interior improvements made to leased property.
If you’re considering updating your business’ infrastructure, you may qualify for a significant tax benefit if you make your investment within the next 15 months.
To stimulate investment in machinery, equipment and other depreciable personal property by small businesses, Section 179 of the federal tax code includes an option to expense qualifying costs rather than depreciating them and recognizing the tax benefit over years. It’s generally referred to as Section 179 expensing.
The Small Business Jobs Act broadened the expensing rules available to small businesses under Section 179. For tax years beginning in 2010 and 2011 only, you can elect to include up to $250,000 of qualified real property in the amount you expense under Section 179–up to half of the $500,000 maximum.
After 2011, qualifying Section 179 deductions are again limited to personal property. Real property will not qualify.
Qualified Real Property, Defined
Generally, to be eligible for expensing under the Act, the real property must be depreciable and must have been acquired for use in an active trade or business. It includes certain qualified restaurant property, qualified retail improvement property, and qualified leasehold improvement property, as follows:
restaurant property―a building or an improvement to a building where more than 50 percent of the building’s square footage is devoted to food preparation and on-premises consumption of prepared meals.
retail improvement property―an improvement to the interior of a nonresidential property that is open to the public and is used for retail sales of tangible personal property to the general public. The improvements must be placed in service more than three years after the building itself was first placed in service.
leasehold improvement property―an improvement to the interior portion of a nonresidential building that is made under or pursuant to a lease and which is occupied exclusively by the lessee or sublessee. Specifically excluded are building enlargements, elevators, escalators, structural components benefitting common areas, the building’s internal structural framework, and certain improvements made by a lessor when the lessor no longer owns the property.
Real property that is used for lodging, is used outside of the country, or is used by any of the following entities is not eligible for Section 179 expensing: government entities, foreign persons, foreign entities and certain tax-exempt organizations. Air conditioning and heating units are also ineligible.
The option to expense qualified real property is not automatic. It requires you to make two elections, in part because choosing to expense your qualified investments in real property is not always the most favorable option. One election is to not treat the cost of the qualified real property as chargeable to a capital account. The other is to treat the property as Section 179 property.
The decision can be a complex one, involving a number of factors and assumptions that should be carefully analyzed, as well as the impact on other tax benefits. Specific considerations include the following.
Your Section 179 deduction in any year is limited by the amount of your taxable income from an active trade or business.
Generally, if your qualifying expenditures exceed this amount, you can carry the excess expenditures to future tax years until they can be deducted. However, you cannot carry over any amount that is attributable to real property to a tax year beginning after 2011. As a result, there is no carryover for unused deductions attributable to real property that you place in service in 2011.
There are special carryover rules to determine the portion of your carryover that is considered to be attributable to qualifying real property.
Qualified leasehold improvement property that is placed in service in 2010 is eligible for bonus first-year depreciation on the portion not expensed. Restaurant and retail improvement property are not eligible for bonus depreciation.
Under Section 179, the expensing election phases out when your business buys more than a specified amount of qualifying property. In other words, for every dollar of qualifying personal and real property you purchase that is over the phase-out amount, the amount you’re allowed to expense for tax purposes is reduced by one dollar.
For 2010 and 2011, the phase-out amount is $2,000,000 per year. If electing to treat your qualified real property as Section 179 property would increase your total investment to more than $2,000,000, electing to expense real property could actually reduce the total amount you’re allowed to expense under Section 179.
If you’re considering an investment in qualifying real property for your business, it’s always a good idea to consult with your Bader Martin advisor. We can explain the potential impact of the investment on your tax and financial plan.