Plan on changes to depreciation rules - many provisions to expire after 2011

As a result of the economic downturn, the federal government has enacted a number of generous provisions in the tax law over the last several years that have been aimed at increasing investment in real property and otherwise improving the economy as a whole. Many of these provisions will expire after 2011 without further legislative action. It should be noted that the provisions discussed below generally also apply to tangible personal property in addition to the types of real property discussed. One such expiring provision is the election to expense up to $250,000 of the cost of "qualified real property" placed in service during the tax year. In very simple terms, "qualified real property" is defined as leasehold improvements made by either a landlord or tenant to a commercial building and certain types of improvements made to property used as a restaurant or improvements made to property that is open to the public and used in a retail trade or business of selling tangible personal property. A similar provision that is also expiring (see below) is known as "100% bonus depreciation." Much like the expense election discussed earlier, this provision allows taxpayers a 1st year depreciation deduction equal to 100% of the cost of certain tenant leasehold improvements to nonresidential buildings. The 100% bonus depreciation provisions, however, do not apply to improvements made to property used as a restaurant ("qualified restaurant property") and improvements made to property that is open to the public and used in a retail trade or business of selling tangible property ("qualified retail improvement property.") Unlike the expensing election, there is no limit on the amount of property eligible for the 100% bonus depreciation deduction. To be eligible for 100% bonus depreciation, the improvements must be placed into service by December 31. An often overlooked benefit of claiming bonus depreciation is that there is no Alternative Minimum Tax (AMT) adjustment for the amount of bonus depreciation and any amount of depreciation on the remaining basis of the property (see discussion below regarding 50% bonus depreciation). This can be a significant benefit for individuals that are subject to AMT as a result of other allowable deductions. It should be noted that many states (including N.Y.) do not allow bonus depreciation. For purposes of these states the property must be depreciated using the otherwise applicable lives and methods. Another provision that is expiring at the end of 2011 is the ability to depreciate qualified leasehold improvement property over 15 years rather than the 39 year life that generally is assigned to leasehold improvements. Assuming that you elected out of the 100% bonus depreciation in 2011 and did not claim an expense deduction for qualified leasehold improvement property placed in service in 2011, you are allowed to depreciate those improvements over a substantially shorter life than under prior (or future) law. Although both the 100% bonus depreciation and 15 year life provisions for qualified leasehold improvements are expiring 2011, you will still be allowed a bonus depreciation deduction in 2012 equal to 50% of the cost of the property. The other 50% will, unfortunately, have to be depreciated over 39 years rather than 15 years as currently allowed (unless legislation is enacted to extend the 15 year life). As mentioned earlier, an election not to claim 100%/50% bonus depreciation is available. Once made, the election is generally not revocable without the consent of the IRS. An election out also causes the depreciation on the property to be subject to AMT adjustments. A word of caution, however, the 50% bonus depreciation provision is currently set to expire at the end of 2012. Therefore, if you are considering making any improvements next year or the following year that will qualify for 50% bonus depreciation, they should be placed in service before the end of 2012 to guarantee that they will be eligible. It should also be noted that the provisions discussed above have certain qualification rules related to original use, acquisition and placed in service dates that are beyond the scope of this article but should be considered when planning on maximizing expense and depreciation deductions related to real property. As you are probably aware, the topic of taxes is the subject of much debate in Congress. With the year rapidly coming to a close, it is unlikely that there will be any legislation passed that will extend or otherwise modify the provisions discussed above. That is not to say, however, that these provisions will not be changed in some manner during the course of next year. Given the general continued poor state of the economy and the looming elections, it remains to be seen what, if any, action will be taken to provide further stimulus in the form of preferential depreciation rules. Sandy Klein, CPA, is a partner at Shanholt Glassman Klein Kramer & Co., New York, N.Y.