In 2010, Congress passed a law that allowed a $250,000 Section 179 deduction on qualifying real property. The law allowed Section 179 deductions on real property placed in service during 2010 and 2011. The law expired on December
31, 2011; however, as part of the Taxpayer Relief Act of 2012 passed a couple weeks ago, the law has been reinstated for 2012 and is extended through 2013.
The qualified real property must be used in the active conduct of a trade or business, and can’t be certain ineligible property (e.g., used for lodging, used outside the U.S., used by governmental units, foreign persons or entities, or certain tax exempt organizations).
There are three types of qualifying real property:
- Qualified leasehold improvement property
- Qualified restaurant property
- Qualified retail improvement property
Qualified Leasehold Improvement Property
Qualified leasehold improvement property means any improvement to an interior portion of a nonresidential building if
- such improvement is made pursuant to a lease by the lessee, sublessee, or lessor of such improved portion
- such portion is to be occupied exclusively by the lessee or sublessee
- such improvement is placed in service more than 3 years after the date the building was first placed in service
Qualified leasehold improvement property does NOT include:
- an enlargement of a building
- any elevator or escalator
- any structural component benefiting a common area
- the internal structural framework of the building
A lease between related persons (e.g., a lease between a taxpayer and his 80% owned business) does not qualify.
Qualified Restaurant Property
Qualified restaurant property includes:
- a building, or
- improvements to a building,
if more than 50% of the building’s square footage is devoted to the preparation of, and seating for on-premises consumption of, prepared meals. Qualified restaurant property is the only category where Section 179 expense is allowed on the building itself, rather than solely on the improvements.
Qualified Retail Improvement Property
Qualified retail improvement property means any improvement to an interior portion of a building which is nonresidential real property if:
- such portion is open to the general public and is used in the retail trade or business of selling tangible personal property to the general public, and
- such improvement is placed in service more than 3 years after the date the building was first placed in service.
Qualified retail improvement property does NOT include:
- an enlargement of a building
- any elevator or escalator
- any structural component benefiting a common area
- the internal structural framework of the building
The Taxable Income Limitation
The amount of Section 179 expense is limited to the business’ taxable income for the year. Any disallowed Section 179 expense is carried forward.
Example: ABC Corp incurs $200,000 in qualified restaurant improvement expenses. Before taking in account the $200,000 Section 179 expense, ABC Corp has $150,000 of taxable income. ABC Corp’s allowable Section 179 expense is limited to its taxable income of $150,000. The remaining $50,000 of Section 179 expense is carried forward to the next year. If ABC Corp has at least $50,000 of taxable income in 2013 it can deduct the remaining $50,000 in 2013.
Disallowed Section 179 expense for real estate cannot be carried forward past 2013. Any Section 179 expense carryforward that cannot be used in 2013 will be treated as property placed in service at the beginning of 2013.
Example: Same as Example 1 except that ABC Corp has $0 taxable income in 2013. The Section 179 expense of $50,000 will not carryforward into 2014, but will be treated as property placed in service on January 1, 2013 that will be expensed over its useful life (15 to 39 years depending on the type of property).
Example 2: XYZ Corp incurs $200,000 of qualified retail improvement property in 2013. XYZ Corp has $80,000 of taxable income before the Section 179 expense. XYZ Corp can deduct $80,000 of Section 179 expense in 2013. The remaining $120,000 of qualifying retail improvement property will not carryfoward into 2014, but is treated as being placed in service on January 1, 2013 and will be expensed over its useful life (15 years).
Section 179 expense on tangible personal property can still be carried forward indefinitely.
Section 179 Expense for Real Property Reduces Section 179 Expense Available for Tangible Personal Property
Prior to the Taxpayer Relief Act of 2012, the Section 179 limit for 2012 was $139,000. The Section 179 limit had been $500,000 in 2011. The Act reinstated the higher $500,000 Section 179 limit for 2012 and extended it through 2013.
It is important to note that the $500,000 expense available for tangible personal property is reduced by Section 179 expense used for real estate improvements.
Example: John buys $600,000 of business equipment and spends $300,000 on qualified leasehold improvements. If John uses $250,000 of Section 179 expense on the leasehold improvements, he may use $250,000 of Section 179 expense on the equipment. Alternatively, for example, John could use $200,000 of Section 179 expense on the leasehold improvements, and the remaining $300,000 of Section 179 expense on the equipment.
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Buzzkill Disclaimer: This post contains general tax information that may or may not apply in your specific tax situation. Please consult a tax professional before relying on any information contained in this post.
Any tax advice contained in the body of this post was not intended or written to be used, and cannot be used, by the recipient for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code or applicable state or local tax law provisions. Any information contained in this post does not fall under the guidelines of IRS Circular 230