Hurry! Expensing of Qualified Real Property Ends in 2013
Normally, when you buy a big-ticket item, you cannot deduct the entire cost in the year of purchase; rather, you must depreciate the cost, deducting a portion over many years. However, a special rule, the expensing election, can help you claim a larger deduction for the year of purchase. In 2010, this expensing election was expanded to include costs you incurred in improving certain types of real property—but this option ends at the end of the year. Recently, the IRS has issued guidance for taxpayers interested in expensing the cost of certain qualified real property.
The expensing election is available for certain qualified real property placed in service in tax years beginning in 2010, 2011, 2012, or 2013. This leaves some, but not very much, time to discuss expensing alternatives with your advisor.
Talk to your advisor about the expensing election before filing an amended return or planning any purchases. Your advisor can examine your situation to evaluate the benefits of the expensing election in light of other avenues, such as bonus depreciation or deferring deductions until later years. For a discussion of other business incentives in the January legislation, see our article, “Extended Bonus Depreciation, Expensing and Tax Credits Aim to Stimulate Business Growth.”
The expensing election allows taxpayers to expense up to $500,000 of the cost of qualifying property in the year it is placed in service, for tax years beginning in 2012 or 2013.
Property eligible for the expensing election is often referred to as “Section 179 property.” The expensing election is often called the Section 179 expensing election, the 179 election, and so forth, because section 179 of the Internal Revenue Code governs the election.
Generally, the expensing deduction is limited to the amount of the taxpayer’s taxable income derived from the taxpayer’s active conduct in a trade or business. If the deduction amount is disallowed due to insufficient income, it may be carried forward for use in future years. However, in situations involving qualified real property, the carryover is limited to only certain years.
Expensing Election Limitations
Limitations on expensing include:
- a dollar limitation on the maximum cost you may expense per year
- an investment limitation based on the cost of all section 179 property placed in service during the year
- a taxable income limitation based on your taxable income derived from the active conduct of a trade or business
After the 2012 calendar year had already ended, the ATRA legislation, also known as the “Fiscal Cliff” tax deal, increased the dollar limitations and investment limitations, for tax years beginning in 2012 (a retroactive increase) or 2013 (a prospective increase).
These taxpayer-friendly year-end changes made by the ATRA meant re-examining the 2012 tax year planning that business owners and their advisors had already done to date, plus adjusting any 2013 tax planning. Because of the retroactive changes, decisions that made sense at the time, may need to be revisited: and that may mean filing amended returns to make the election to expense qualifying property placed in service during 2010, 2011, 2012, or 2013. You may also file an amended return to increase the portion of the cost of expensed property. According to the IRS guidance, an increase in the amount expensed is not a deemed revocation of a prior election for that year.
As increased by ATRA, the maximum amount you may expense for 2012 or 2013 is $500,000. This amount is reduced as the amount of section 179 property placed in service exceeds a $2 million investment limitation (which was also increased by ATRA).
|Current Amounts |
|Tax Years |
|Dollar Limitation ||Investment Limitation |
|2012 ||$500,000 ||$2 million |
|2013 ||$500,000 ||$2 million |
|2014 et. seq. ||$25,000 ||$200,000 |
Currently, the deduction is completely phased out if the property placed in service exceeds $2.5 million. Prior to January’s Fiscal Cliff legislation, this phased-out amount was much lower—and it will drop back to only $225,000 beginning in 2014.
Restaurant, Retail Store and Leasehold Improvements Qualify Until 2014
Traditionally, the expensing election could not be claimed for an improvement to real property. This meant that if you bought an oven for your restaurant, you could expense the cost, but if you remodeled your restaurant you had to deduct those costs over a very long period of time. However, in 2010, this restriction was lifted—for a short period of time for certain types of property.
Certain qualified real property (QRP) is one category of the types of property eligible for the expensing election. The maximum amount of QRP that may be expensed for a tax year beginning in 2012 or 2013 is $250,000, rather than the $500,000 permitted for other types of property.
The $250,000 limitation applies only to QRP. The amount of QRP you expense (up to the $250,000 limit) is deducted from the overall $500,000 limit. You can elect to expense other types of property (for example, new chairs for your reception area), up to the $500,000 limit.
Recapture rules also apply to dispositions of property. QRP generally includes:
- Qualified restaurant property
- Qualified leasehold improvement property
- Qualified retail improvement property
Some property is ineligible, such as air conditioning and heating units.
Extensions through 2013. Prior to the Fiscal Cliff legislation, the expensing election was available only for QRP property placed in service in tax years beginning in 2010 or 2011. Also, a QRP deduction disallowed by the taxable income limitation could not be carried over beyond 2011. Instead, the amount was recovered through depreciation deductions.
However, ATRA extended the ability to expense QRP for tax years beginning in 2012, which was a retroactive extension, and in 2013, which was prospective. Also, a QRP deduction disallowed by the taxable income limitation may not be carried over beyond tax years beginning in 2013 (not 2011). Instead, the amount is recovered through depreciation deductions.
Allocating Carryovers of Amounts in Excess of the Annual Limits
Prior to the Fiscal Cliff extensions, some taxpayers with disallowed deductions, that were not carried over beyond 2011, may have started recovering the amounts through depreciation deductions. If you are one of these taxpayers, you can choose to 1) continue doing so, or 2) file amended returns to carryover the initially disallowed deductions to 2012 and 2013, provided other requirements are met (e.g., tax years being open, collateral adjustments). Recent IRS guidance address retroactive increases in expensing made by the American Taxpayer Relief Act (ATRA), enacted in January, 2013, plus filing an amended return to claim an increased expense deduction. It also illustrates allocation for carryover and recapture purposes. Work closely with your tax professional as decisions made for one tax year will ripple through to impact your tax liability in years to come.
Allocating the carryover amounts beyond 2013. QRP carryovers may not go beyond tax years beginning 2013, but other types of Section 179 carryovers may do so. Accordingly if you elect to expense QRP and other types of section 179 property you must allocate, pro rata, any expensing deductions disallowed by the taxable income limitation.
During 2012, Edith’s Evolutionaries, a calendar year taxpayer, purchased and placed in service equipment costing $100,000 and QRP costing $200,000. It had no other asset purchases, nor any carryover of disallowed deduction from prior taxable years. It elected to expense the entire cost of the equipment and of the QRP. However, because of the taxable income limitation, the maximum expensing deduction Edith’s could claim for 2012 was only $180,000. Consequently, Edith’s has a $120,000 carryover of disallowed deduction to 2013.
This $120,000 carryover amount is allocated pro rata between the equipment and the QRP. Thus, $80,000 of the carryover amount is allocated to the QRP and $40,000 of the carryover amount is allocated to the equipment.
|Allocation of $120,000 Carryover Amount |
|Allocation Ratio ($200,000 QRP / $300,000 Total) ||66.67% |
|Carryover Amount Allocated to QRP ||$80,000 |
|Allocation Ratio ($100,000 Equipment / $300,000 Total) ||33.33% |
|Carryover Amount Allocated to Equipment ||$40,000 |
Same facts as in Example 1. In 2013, Edith’s has no taxable income and no asset purchases. As a result, in its 2013 tax year, Edith’s cannot use any portion of the $80,000 carryover of disallowed deduction from 2012 that is attributable to the QRP. Also, disallowed expensing deductions attributable to QRP cannot be carried over to taxable years beginning after December 31, 2013. Accordingly, Edith’s is treated as if the expensing election made in 2012 to expense $80,000 of the cost of the QRP placed in service in 2012 had not been made. The $80,000 cost of the QRP is treated as placed in service by Edith’s on January 1, 2013 (the first day of its last taxable year beginning in 2013) for purposes of computing depreciation. However, the $40,000 carryover of disallowed deduction from 2012 that is allocated to the equipment is carried over to 2014.
The ability to expense assets in the year of purchase can be an excellent strategy to lower your tax bill for the year of purchase. This is especially true in the case of qualified real property improvements. Without the expensing election, the costs you incur in 2013 would have to be depreciated over 15 years.
If you are contemplating improvements to your restaurant, store or other property that you lease, you should definitely consider making those improvements in 2013. Not only will you have the option of deducting the first $250,000 of costs, you will be able to depreciate the remainder over 15 years. Starting in 2014 (absent a Congressional reprieve) you will be hit with a double-tax-whammy. You will not be able to expense any of the amount in the first year and you will have to deduct the remainder over 39 years, rather than the current 15-year period.