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December 2020

Final Regs Expand Property Eligible for Like-Kind Exchanges

By Tom Ochsenschlager, JD, CPA

Last month, the IRS issued final regulations (TD 9935) explaining the limitations on like-kind exchanges that were imposed in the Tax Cuts and Jobs Act (TCJA). The TCJA limited the ability to qualify for a tax-free exchange under Section 1031 to exchanges of real property. Accordingly, exchanges of personal or intangible property that qualified for tax-free exchange prior to the TCJA no longer do.

In addressing the TCJA limitation, the proposed regulations limited the definition of real property to land, buildings and their permanent structural components and provided a “purpose or use test” that excluded incidental property located within the real property that was unrelated to the use or occupancy of the property such as machinery and equipment.

The final regulations revoke the purpose or use test, thereby expanding the definition of real property to include property held for the productive use in a trade or business. Additionally, the proposed regulations provide that even property not considered real property under state law may qualify based on the facts and circumstances. However, it is clear in the regulations that regardless of state law definition of real property, intangibles such as artwork, patents, intellectual property, stock in a corporation and a partnership interest do not qualify as assets eligible for tax-free exchange.

The final regulations are generally effective for exchanges of real property completed after Dec. 31, 2017. An amended return may be necessary to take advantage of the expanded definition of property now eligible for exchanges that occurred in 2018 and 2019 that did not qualify under the proposed regulations.

https://www.irs.gov/pub/irs-drop/td_9935.pdf


100% Depreciation Rules

By Tom Ochsenschlager, JD, CPA

The bonus depreciation rules were passed as part of the Tax Cuts and Jobs Act (TCJA). These rules generally permit a 100% deduction on Form 4562 for most depreciable assets the year they are placed in service beginning after Sept. 27, 2017 and before Jan. 1, 2023. After 2022, the rate for bonus depreciation phases out. It will drop to 80% in 2023, 60% in 2024, 40% in 2025 and 20% in 2026.

Applicable Property

To be eligible for the write-off, the property must have a useful life of 20 years or less. That includes vehicles, equipment, furniture and fixtures, machinery, computer software and qualified improvement property such as improvements to the interior of nonresidential property. Special rules are provided for self-constructed property.

If the property is used for both personal and business purposes, such as a vehicle, it is eligible for the bonus depreciation write-off only if it is used in the business more than 50% of its total use.

The deduction can be claimed in the year the applicable asset is placed in service, which in some instances may be later than the year the property is acquired.

Special rules apply to limit the availability of the bonus depreciation for passenger vehicles such as automobiles, SUVs, pickups and vans with a vehicle weight of 6,000 pounds or less. For these vehicles, if “bonus” depreciation is elected, the depreciation deduction is limited to $18,100 in the year placed in service ($10,000 “normal” depreciation plus $8,100 bonus depreciation). In years after the vehicle is placed in service, the depreciation deduction is the same as depreciation would be without the bonus election, which is $16,100 in the second year, $9,700 in the third year, and $5,760 in the later years. See the tables in Rev. Proc. 2020-37.

Differences from Section 179 Depreciation

The 179 deduction is limited to the business’ taxable income before considering the deduction. The remainder can be subject to “regular” depreciation rules or can be carried forward. The TCJA bonus depreciation, however, is not limited to taxable income and accordingly can generate a loss to be carried back for a refund of prior taxes. 

The TCJA also increased the limit for the 179 deduction to $500,000 in 2017 and $1 million in the following years. However, the benefit of the 179 deduction is phased out if purchases that would otherwise qualify exceed $2.5 million. 

Unlike the 179 deduction, the TCJA bonus depreciation is applicable to used property if the taxpayer acquired the used property from an unrelated party and it was not acquired in a tax-free transaction.

Details for the application of the TCJA bonus depreciation are available in the 137 pages of regulations https://www.irs.gov.gov/pub/irs-drop/td-9916.pdf.

https://www.irs.gov/pub/irs-drop/rp-20-37.pdf


Expenses Covered by PPP in 2020 Are Not Deductible

While our earlier blog stating expenses covered by a PPP loan were not deductible was correct at the time it was posted, with the change in the law that is retroactively effective, the earlier blog should now be ignored.

See IRS link for update:

Eligible Paycheck Protection Program expenses now deductible | Internal Revenue Service (irs.gov)

 

 

The Payroll Protection Program (PPP) was enacted as part of the Coronavirus Aid, Relief and Economic Security Act (CARES Act). Section 1106 of the CARES Act provides forgivable loans to eligible businesses if they retain their employees for the covered period, and the funds from the loans are used for payroll costs, health care benefits, interest on debts related to the business, rents and utility costs. 

To the extent any of these costs are covered by a PPP loan, these expenses are not tax deductible if the loan is forgiven based on current IRS guidance. The CARES Act specifically states that the forgiveness of the debt is excluded from the business’ income. However, the IRS states that Section 265 denies a deduction for expenses attributable to tax-exempt income and that the forgiveness of the loan is the equivalent of tax-exempt income. Accordingly, the IRS’ position is that taxpayers that received PPP loans are not permitted to claim a tax deduction for expenditures related to the loan if the PPP loan is forgiven. (This is a controversial position that, in effect, diminishes or denies the benefit of the PPP program and may be challenged going forward.)   

This raises the question of how to treat these expenses incurred in 2020 if the loan is still outstanding at the end of the year. Rev. Rul. 2020-27 states that the expenditures covered by the PPP are not deductible on the business’ 2020 tax return even where the business has not applied for or received forgiveness of the debt if there is a reasonable expectation that the loan will be forgiven. Rev. Proc. 2020-51 does provide that the expenses covered by the PPP loan are deductible if and when the forgiveness of the loan is denied or the taxpayer decides not to request forgiveness.  

https://www.irs.gov/pub/irs-drop/rr-20-27.pdf

https://www.irs.gov/pub/irs-drop/rp-20-51.pdf