Depreciation and Like-Kind Exchange Planning

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The Tax Cuts and Jobs Act (TCJA) brought about changes in Sec. 179, bonus depreciation and like-kind exchanges for your clients. Let’s recap these tax changes that apply to tax year 2018 and beyond.

Sec. 179 – Depreciation

For 2018, the additional first year depreciation [bonus or Sec. 168(k)] is 100 percent of the cost. Sec. 179 has limits of $1 million maximum total with a phase-out limit of assets eligible for Sec. 179 starting at $2.5 million. The Sec. 179 limit on a sports utility vehicle (SUV) remains at $25,000. For 2019, you still can take 100 percent bonus depreciation, while Sec. 179 limits increased to $1.02 million for maximum total and $2.55 million for beginning of the phase out. The Sec. 179 limit for a SUV increases to $25,500.

A significant TCJA change for depreciation and Sec. 179 is to allow certain used property to be eligible. The TCJA defines qualified property as the original use, which begins with the taxpayer or the acquisition of which by the taxpayer, that meets the acquisition requirements of Sec. 168(k)(2)(E)(ii).

The original use definition stays the same as before the TCJA: Any new property used for the first time in a trade or business, such as when a business owner goes to a supplier to purchase a new tractor that has never then used. Under the new TCJA acquisition requirements, used property can now qualify for bonus depreciation and Sec. 179 due to the expanded definition from the TCJA as long as the following factors apply:

  • The taxpayer or its predecessor didn’t use the property at any time before acquiring it.
  • The taxpayer didn’t acquire the property from a related party.
  • The taxpayer didn’t acquire the property from a component member of a controlled group of corporations.
  • The taxpayer’s basis of the used property is not figured in whole or in part by reference to the adjusted basis of the property in the hands of the seller or transferor.
  • The taxpayer’s basis of the used property is not figured under the provision for deciding basis of property acquired from a decedent.
  • The cost of the used property eligible for bonus depreciation doesn’t include the basis of property determined by reference to the basis of other property held at any time by the taxpayer (for example, in a like-kind exchange or involuntary conversion).

Tax planning with depreciation is an important aspect in helping your clients make the right decisions of choosing between taking bonus depreciation or Sec. 179 on an asset. Keep in mind that for 3-, 5-, 7- and 10-year class assets, you can take Sec. 179 on a portion of the asset; on the remaining basis, you can take bonus depreciation. Here is a chart to help you plan:

Sec. 179 Bonus Depreciation
Limited amount Yes

$1 million (2018)

$1.02 million (2019)

No
Investment income Yes

$2.5 million (2018)

$2.55 million (2019)

No
Generates a net operating loss No Yes
Allowed for investment property No Yes
Building use requirement Must be >50% No minimum percentage
Subject to recapture Yes No
New and used property Yes Yes
3- 5-, 7- and 10-year class property Yes Yes
15- or 20-year class property No Yes
Nonresidential qualified improvement property (39 year) Yes No
Alternate depreciation system property Yes No

 

Like-Kind Exchanges

Effective 2018, exchanges of machinery, equipment, vehicles, artwork, collectibles, patents, and other intellectual property and intangible business assets generally do not qualify for like-kind exchanges; only real property qualifies. Real properties generally are of like-kind, regardless of whether they’re improved or unimproved. For example, an apartment building would generally be like-kind to another apartment building, or city property for a ranch or farm, or commercial building for vacant lots. However, for like-kind exchange planning with your clients, you need to know that real property in the United States does not qualify for a like-kind exchange of real property outside our borders.

The purpose of like-kind exchanges is to defer any gains into the future. The future can also mean continuously making like-kind exchanges for other properties in order to keep deferring those gains for decades, including the depreciation recapture portion (Sec. 1250). The eventual sale of the property would then trigger the ordinary gain from the depreciation recapture and the remaining as a capital gain. The ordinary gain would be tax at the ordinary income tax rates, while the capital gains would be at the maximum of 20 percent.

Tax planning is essential under the TCJA when determining whether to use bonus depreciation versus Sec. 179 on newly acquired assets, and like-kind exchanges with real property. As a tax professional, you can use your knowledge of these asset acquisition factors to properly advise clients on making the right decisions.

Editor’s note: Learn about three depreciation perks for your clients in this article from Mike D’Avolio, CPA, JD.

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