Qualify Property Improvements by December 31 for 100 Percent Deduction
Year-end tax planning is more important than usual if you are building or remodeling real estate. Properties may qualify for a 100 percent bonus depreciation deduction if they are completed by December 31, 2011, but here’s where things can get muddy.
The nature of real estate improvement sometimes means a drawn-out construction process and unforeseen delays. This makes the common deduction qualification—the date an item is “placed into service”—less clear.
“There are things you can do now—schedule the final inspection to obtain a certificate of occupancy, take a picture of a completed property, or strategize with your contractor to figure out how to meet the deadline,” says Bob Sniegowski, a construction principal with LarsonAllen. “But don’t wait until the last week of December. By then inspectors may not be available or building code deficiencies may be too significant to remedy before year-end.”
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If your construction project is really big (for instance, a facility with two wings), it might be helpful to break the work into two clearly identifiable phases.
—Bob Sniegowski
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Real estate improvement assets generally fall under the “self-constructed property” rules which means that the 100 percent depreciation applies if the contract date begins after September 8, 2010. This date is generally when the project’s written contract is signed. Most projects currently in process will meet this test. Projects with earlier contract dates will need to meet additional requirements.
The unusually favorable deductions will be scaled back to 50 percent in 2012 and zero in 2013 and after—unless Congress steps in.
If your construction project is really big (for instance, a facility with two wings), it might be helpful to break the work into two clearly identifiable phases. “That way at least half of your project may qualify for the 100 percent deduction,” says Sniegowski.
We’ve analyzed the details to help you and your business think through the options.
Definition of placed in service
According to
IRS Publication 946, a property is placed into service when it is ready and available for a specific use, even if the property is not being used. “In a recent IRS audit involving a client, the IRS relied on the certificate of occupancy date as the date the building was placed ‘in service,’” explains Erin Peterson, a manufacturing and distribution senior accountant with LarsonAllen. “Dated photographs, inspection reports, patient records, or inventory receiving reports may also support your position that the property is in service.
Establishing the contract date
The contract date is an important part of establishing the correct qualifying period for 50 percent or 100 percent bonus depreciation. For self-constructed property, the contract date is the date the written binding contract is signed by the taxpayer.
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Dated photographs, inspection reports, patient records, or inventory receiving reports may also support your position that the property is in service.
—Erin Peterson
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Bonus depreciation timeline and background
The
Small Business Jobs Act of 2010 created
short-term investment incentives, including a provision that allowed a 50 percent deduction for the cost of new property placed in service during 2010 (but only for
qualifying properties). For example, improvements to property leased to a nonprofit or tax exempt entity may be disqualified from bonus depreciation.
The Tax Relief Act, passed in December of 2010, retroactively expanded the 50 percent bonus depreciation provision to a 100 percent deduction, effective for new assets placed in service on and after September 9, 2010 through December 31, 2011. For calendar 2012, the provision reverts back to 50 percent bonus depreciation, and zero in years thereafter.
Qualifications
Only the first owner and user of the property are eligible for bonus depreciation. Also, the asset must be new property instead of used property, and the asset should have a recovery period of 20 years or less, (unless it is depreciable computer software, water utility property, or qualified leasehold improvement property).
100 percent versus 50 percent
Construction start dates and in-service dates are key tests to determine if 50 percent or 100 percent bonus depreciation applies. The day a taxpayer begins constructing, manufacturing, or producing the property is the day the taxpayer acquires the property. A taxpayer is deemed to meet the acquisition requirement the day a written binding contract is signed. (Under certain circumstances, the date when 10 percent or less of the construction activity has been completed may be a factor in determining the start of the qualifying period for bonus depreciation.)
The table below lays out the application of bonus depreciation and the effective dates for tax years 2008, 2009, 2010, 2011, and 2012—based on legislation effective through October 31, 2011.
In Service
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Contract Date
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Bonus Depreciation
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1/1/12–12/31/12
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After 1/1/08
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50 percent
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1/1/11–12/31/11
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After 9/8/10
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100 percent
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1/1/11–12/31/11
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After 1/1/08 and before 9/9/10
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50 percent
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9/9/10–12/31/10
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After 9/8/10
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100 percent
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1/1/10–12/31/10
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Before 9/9/10
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50 percent
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1/1/08–2/31/09
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After 1/1/08
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50 percent
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Three examples
The following examples illustrate how the contract and in-service dates affect the bonus depreciation deduction of self-constructed property:
Example 1: Donald Steep entered into a contract with XYZ contractor on May 1, 2010 to construct a manufacturing warehouse. The construction project was 50 percent complete before September 9, 2010. The project was completed and Mr. Steep received the certificate of occupancy on February 12, 2011. He can begin to depreciate it in February 2011 and use 50 percent bonus depreciation for qualified bonus property. The property is not eligible for 100 percent bonus depreciation since the contract was entered into before September 9, 2010.
Example 2: On March 4, 2010, Sue Thorn began renovation of a house to convert it to residential rental property. She had it ready for rent on July 5, 2010. At that time, she began to advertise it for rent in the local newspaper. The renovation is considered placed in service in July when it was ready and available for rent. She can begin to depreciate it in July and use 50 percent bonus depreciation for qualified bonus property.
Example 3: James Elm is a building contractor who specializes in constructing office buildings and commercial rental property. He began construction of an office building with two projects consisting of two distinct suites on February 6, 2011. The suites were rented to two unrelated tenants. Suite one was completed and available to tenant one on October 15, 2011. Suite two was completed and available for tenant two on January 24, 2012. James can begin to depreciate suite one in October 2011 and use 100 percent bonus depreciation for qualified bonus property. He can begin to depreciate suite two in January 2012 and use 50 percent bonus for qualified bonus property. He can claim two placed in service dates since the costs and the layout of the suites were identifiable in two separate projects.
Other depreciation considerations
Several other depreciation provisions may be more advantageous for your current tax situation:
Section 179
Section 179 was expanded by the
Small Business Jobs Act of 2010 to allow taxpayers to expense the cost of certain qualifying property. Limitations, qualifying tests, and the asset class of the expenditure are considerations in properly claiming this deduction.
Timing is important. For the tax year beginning in 2011, the Section 179 maximum deduction is $500,000. But for the tax year beginning in 2012, the deduction drops to a maximum of $139,000.
Repairs and maintenance
Certain capital expenditures may be considered repairs and maintenance expense rather than capitalized assets. Limitations, qualifying tests, and support criteria of the expenditure are considerations in properly claiming this deduction.
Option to elect out of bonus
In some cases, bonus depreciation may not present the best answer for every circumstance. In those situations, taxpayers may elect not to deduct bonus depreciation by class of property.
How we can help
The most efficient tax strategy for your real estate projects is to plan the capitalization of the projects’ costs well before year-end. Speak with your tax advisor about the incentives available that provide the greatest opportunity to maximize the depreciation deductions in your 2011 tax return.
Bob Sniegowski, Construction and Real Estate Principal
rsniegowksi@larsonallen.com or 612-376-4659
Erin Peterson, Manufacturing and Distribution Senior
epeterson@larsonallen.com or 612-397-3226
View our tax principals.