Over the past several months, Congress and the IRS promulgated tax provisions extending tax savings opportunities that benefit real property owners and clarifying new rules regarding the Foreign Investment Real Property Tax Act (“FIRPTA”). Some of these provisions allow taxpayers to accelerate deductions or claim tax credits. Most of the extensions applied to provisions in the Protecting Americans from Tax Hikes Act of 2015 (“PATH Act”), passed on December 18, 2015. Additionally, on February 17, 2016, the IRS issued regulations addressing changes to FIRPTA made by the PATH Act.
Below is a summary of some of the provisions affecting real property:
- Internal Revenue Code 179 deduction (Election to Expense Certain Depreciable Business Assets)
Internal Revenue Code Section 179 allows a taxpayer to immediately deduct the cost of purchasing qualifying property, but only allowed to the extent of the taxpayer’s taxable income and subject to expensing and investing limitations. Prior to the enactment of the PATH Act, the expensing limitation for 2015 was to be 25,000, with an investment limitation of $200,000. The PATH act permanently set the IRC Section 179 expensing limitation at $500,000, with a $2,000,000 overall investment limit before phase-out begins. These figures are indexed to inflation starting in 2016. The PATH act also allows air conditioning and heating units to be included as IRC Section 179 property. Finally, prior to 2016, only $250,000 of qualified real property may be expensed. After 2015, that limitation is eliminated.
- Bonus Depreciation
Bonus depreciation provides a second method for taking an immediate deduction for asset acquisitions. Bonus depreciation was set to sunset in 2014, and then was extended by the PATH Act for property acquired and placed in service during 2015 through 2019. The bonus depreciation percentage is 50% for property placed in service during 2015 through 2017, then phases down, with 40% deductible for assets acquired in 2018 and 30% deductible for assets acquired in 2019. Additionally, the PATH act extended a provision allowing taxpayers to elect to accelerate the use of the AMT credit in lieu of bonus depreciation for property placed in service during 2015. By accelerating the AMT credits, taxpayers can reduce regular and/or AMT tax to obtain a refund. Moreover, the Act modified bonus depreciation to include qualified improvement property; defined as any improvement to an interior portion of nonresident real property placed into service after the building was first placed into service and which does not involve 1) enlargements, 2) elevators/escalators, and 3) internal structural framework.
- Revenue Procedure 2015-56
Restaurants and retail establishments generally undertake remodeling projects to remain competitive and to improve the customer experience. Revenue Procedure 2015-56 created a safe harbor for deducting costs incurred to refresh or remodel a restaurant or retail establishment. This safe harbor, which does not apply to the initial buildout of a space or to the remodeling of motor vehicle dealers or gas stations, allows qualified taxpayers to deduct 75% of qualified remodel/refresh expenditures in the current year and depreciate the remaining 25% over the life of the asset in a “general asset account”(i.e. assets grouped into a single account which uses the same depreciation method, recovery period, convention and placed-in-service date). To qualify for the safe harbor, the taxpayer must have applicable financial statements (usually audited financial statements) and the remodeling cannot result in a betterment, restoration, or an adaptation of more than 20% of the total square footage of the qualified building. To adopt this safe harbor, the taxpayer must file a change in accounting method form along with the tax return.
- Energy Efficient Commercial Building Tax Deduction
The PATH Act extended a tax incentive for creating energy- efficient buildings, with the above- the- line deduction for energy- efficient improvements to lighting, heating, cooling, ventilation and hot water systems in commercial buildings now running through 2016. The deduction is $.30 to $1.80 per square foot, depending on technology and amount of energy reduction. The maximum $1.80 per square foot deduction is available if the improvements reduce the building’s total energy and power costs by 50% or more in comparison to standard building measurements. Thus, if the taxpayer makes improvements to a 100,000 square foot commercial building that qualifies for a $1.80 per square foot deduction, the taxpayer’s above- the- line deduction will be $180,000.
- Extension and Modification of Empowerment Zone Tax incentive
The PATH act extended through 2016 the tax benefits for certain businesses and employers operating in empowerment zones (economically distressed areas). An employer in an empowerment zone is entitled to a credit of 20% of the first $15,000 of wages to a qualified zone employee paid during the tax year (equaling $3,000 per qualified employee). A qualified zone employee is an empowerment zone resident who performs substantially all of his/her services for the employer’s business located within the zone. An employer who receives a credit for a qualified employee must reduce its deduction for wages by the amount of the credit claimed during the tax year. Finally, this credit can reduce alternative minimum tax liability by up to 25%.
- FIRPTA Changes
On February 17, 2016, the IRS issued regulations reflecting changes made to FIRPTA by the PATH Act. The rules relate to the taxation and withholding requirements that apply to the disposition of U.S. real property interests by foreign persons. Generally, a foreign person treats gain on the disposition of a US Real Property Interest (USRPI) as if the foreign person was engaged in a US trade or business and the gain or loss was effectively connected with that trade or business. The PATH Act added an exception to what is considered to be a USRPI for situations where the corporation does not hold a USRPI as of the date of its disposition of the corporation’s stock and the corporation disposes of all of its USRPIs held during an applicable testing period in a transaction in which the full amount of gain, if any, was recognized. For this exception to apply, neither the corporation nor its predecessor can have been a Real Estate Investment Trust. Additionally, the PATH Act increased the general withholding rate imposed on the transferee when a foreign person disposes of a USRPI from 10% to 15% after February 16, 2016. A 15% withholding rate is applicable to distributions by certain corporations, partnerships, trusts and estates. However, the Act retained the 10% withholding rate for a disposition of property that is acquired by the transferee for use as a residence and the amount realized on the transfer is greater than $300,000 but less than $1,000,000.
These new provisions have extended opportunities for businesses to accelerate deductions and/or recognize certain tax credits or above- the- line deductions; and helped clarify the FIRPTA rules. If you have any questions regarding these provisions, please contact Andrew Cohen at Acohen@Friedmanllp.com, or your Friedman LLP Tax Advisor.