Tax Reform Blunder has Repercussions for Restaurants and Retailers
Businesses are missing out on tax breaks due to unintended errors in the way the tax reform law was worded. Is a band-aid on the way for this boo-boo? Technical corrections are needed to TCJA relating to Qualified Improvement Property (QIP) and the effective date for Net Operating Losses (NOLs) Carryback/Carryforward changes.
“Qualified Improvement Property”
The Tax Cuts and Jobs Act eliminated the separate definitions for “qualified leasehold improvement,” “qualified restaurant property” and “qualified retail improvement property,” which were previously provided a statutory 15 year recovery period. It then expanded the definition of “qualified improvement property” to include “any improvement to the interior of a building if that building is nonresidential real property and such improvement is placed in service after the date such building was first placed in service.” All such property is now treated the same, regardless of whether the improvements are property subject to a lease, placed in service more than three years after the date the building was first placed in service, or made to a restaurant building. QIP does not include the enlargement of the building, any elevator or escalator, or the internal structural framework of the building.
The 15-year class-life provision, unfortunately, was not added. So since QIP was left off the list of 15-year depreciation period property, “qualified improvement property” is not eligible for TCJA’s 100% bonus depreciation. Instead of being able to immediately deduct the entire cost of renovations and other improvements made to non-residential real estate, after 39 years businesses will only get a little more than 40% of the total cost being written off, when compared with the intended 100%. This may cause some Fuoco Group restaurant and retail clients to miss out on a write-off and necessitate postponement of renovations to aging facilities which could potentially hurt their businesses.
Depreciation is an accounting concept in which the value of an asset is reduced over time, and depreciation expense has historically been allowed as a tax deduction against revenue. The authors of the TCJA had intended for the businesses to be able to write off the full costs of eligible improvements in one year. If the statute had the words “any qualified improvement property” in the correct place it would have made these improvements qualify for the first-year write-offs that apply to equipment purchases and other items.
The government released proposed bonus depreciation regulations on August 3, 2018, but this first draft leaves 2018 forward QIP ineligible for bonus depreciation – a significant issue for companies with real estate holdings since nonresidential interior renovations generally qualify as QIP. QIP still only qualifies for bonus depreciation if acquired and placed in service between September 27, 2017 and December 31, 2017.
Net Operating Loss Carryback/Carryforward Changes
The TCJA made significant changes to the mechanics of net operating losses (NOLs). Notably, most taxpayers may no longer carry back losses. The TCJA also restricts the NOL deduction to 80 percent of taxable income. A correction is needed that relates to the effective date of a provision that generally bans businesses from carrying back net operating losses to prior years. Lawmakers had intended the effective date for the changes would be tax years beginning after December 31, 2017. But the law instead says it applies for taxable years ending after December 31, 2017. As written, fiscal year taxpayers with years ending in 2018 are subject to the new restrictions for their 2017 fiscal year, even if the majority of their tax year was in 2017. Calendar year taxpayers are not impacted by this discrepancy.
Both the repeal of carrybacks and the 80% limitation, by deferring more of the loss recognition to future years, may increase total federal income taxes owed. Companies with intermittent loss years and startups with initial years of losses may fare less well than previously. The changes to the NOL rules put greater emphasis on the timing of income and deductions when assessing expected future tax liabilities. Businesses may no longer be able to rely on the NOL carryforward provisions to result in no federal tax liability in years of low taxable income relative to prior loss years.
While technical errors are not uncommon, these two could be hard to fix. No Democrat votes were needed to pass The Tax Cuts and Jobs Act, but Republicans will require help from senators across the aisle to fix these errors. Technical fixes to the tax law might be included in a year-end package after the midterm elections.
Your Fuoco Group professional advisors will keep you posted on developments. In the meantime we suggest you temporarily put renovation plans on hold and reconsider opportunities to purchase or lease new locations that would require substantial improvements.
Contact Us: Tax planning is as essential a part of the strategy for success in restaurant or retail operations, and just as important as merchandise or menu, ambience, and customer service. Businesses that have put assets into place this year may still have improved options for claiming bonus depreciation. No matter what industry you are in, our Fuoco Group professionals can provide the perspective and insight needed to grow your business and capitalize on tax reform opportunities while minimizing tax liabilities. Contact us toll free at 855-534-2727 or email Lou Fuoco, CPA at lfuoco@fuoco.com.