Tax Strategist InsightIs your business looking to preserve cash flow? Strategic fixed asset planning can unlock valuable tax benefits, providing companies with immediate cash that can be reinvested in the business or used to help improve financial performance. This article explores key strategies in fixed asset planning — including opportunities surrounding shorter-lived qualified improvement property (QIP) and repairs and maintenance costs, as well as dealing with the phase-out of bonus depreciation. Additionally, it highlights the advantages of using statistical sampling methodologies when undertaking fixed asset planning.
Why Engage in Fixed Asset Planning?
Fixed asset planning is the process of enhancing the tax treatment of a company's depreciable assets. As most tax-basis fixed asset systems are linked to financial reporting, when capital spending is entered into the fixed asset system, asset categories are generally assigned by the financial reporting team. These asset designations are then used to automatically assign tax lives, tax recovery methods, and other tax depreciation rules. Unfortunately, this process often overlooks important tax incentives and can become outdated as tax rules or the company’s facts and circumstances change, creating the need for regular fixed asset tax reviews.
The value of traditional fixed asset planning is the ability to accelerate tax deductions, thereby reducing current tax liabilities and resulting in current cash savings. For example, by performing a detailed review of nonresidential building property, which is recovered over 39 years, businesses might be able to reclassify a portion of that spending to a shorter tax life or even achieve an immediate tax deduction.
Opportunities identified through fixed asset planning generally require the company to file for an accounting method change with the IRS. Revenue Procedure 2024-23 lists several automatic accounting method changes that allow businesses to adjust their tax treatment of fixed assets without extensive IRS involvement. These method changes often result in a Section 481(a) adjustment, which captures the cumulative effect of the change and can provide immediate tax benefits. Importantly, a Section 481(a) adjustment allows a true-up to be recognized on a current return without the need to amend prior year tax returns. To calculate a Section 481(a) adjustment, a company can go as far back as they have tax basis to make the depreciation changes, even if the asset was placed in service in a year now closed under the statute of limitations.
Qualified Improvement Property (QIP)
QIP refers to improvements made to the interior portion of a nonresidential building. Introduced by the Tax Cuts and Jobs Act (TCJA), Congress intended QIP to qualify for 100% bonus depreciation. However, due to a drafting error, the TCJA initially assigned a 39-year recovery period to QIP, making it ineligible for bonus depreciation. The CARES Act, enacted in March 2020, corrected this error retroactively to January 1, 2018.
To qualify as QIP (eligible for a 15-year recovery period and bonus depreciation), the improvements must:
- Be made by the taxpayer to the interior of a nonresidential building.
- Be placed in service after the building was first placed in service.
- Not include enlargements, elevators, escalators, or internal structural framework.
The confusion around the TCJA drafting error caused many businesses to miss classifying large pockets of spending as QIP from 2018 through 2020. Companies have the opportunity to review spending from this period, reclassify qualified costs to 15-year QIP, and take bonus depreciation where allowable. These reviews can be completed as part of a fixed asset lookback study and savings can be captured through an automatic accounting method change with a Section 481(a) adjustment.
Companies in the following situations also may want to undertake a fixed asset study to retroactively identify additional QIP:
- Companies that do not complete an extensive QIP review each year and, instead, only classify as QIP the largest projects that clearly qualify.
- Companies without sufficient time and other resources to properly identify their QIP deductions between year end and the filing of their return.
It is important to note that QIP is qualified dollar-by-dollar and not project-by-project, so an extensive review is often required to increase deductions. QIP benefits currently remain available for future tax years and are most impactful when bonus depreciation rates are higher.
Capital Expenditures vs. Deductible Repairs
Regulations finalized in 2014 (the tangible property regulations) provide guidelines under IRC Section 263(a) for distinguishing between capital expenditures and deductible repairs. These regulations were a significant rule change and resulted in an extensive amount of work for companies to be compliant. However, many businesses have not diligently followed these regulations over the last several years, creating opportunities to revisit their fixed asset planning strategies.
The tangible property regulations govern which expenditures can be deducted when incurred versus those that must be capitalized and depreciated. The rules are complex, heavily dependent on the taxpayer’s facts and circumstances, and, absent a few safe harbors, provide no bright-line tests. A fixed asset study can identify and support classification of costs as immediately deductible repairs, enhancing tax savings.
Bonus Depreciation
Another reason to consider a fixed asset study is for the sunsetting of full or partial expensing. Bonus depreciation under IRC Section 168(k) allows businesses to accelerate deductions for certain qualified property. The TCJA introduced 100% bonus depreciation for property placed in service on or after September 27, 2017. However, the TCJA also provides a phase-out, with bonus depreciation decreasing by 20% each year starting in 2023.
Under the TCJA, the bonus depreciation percentages are as follows:
- 80% for property placed in service in 2023.
- 60% for property placed in service in 2024.
- 40% for property placed in service in 2025.
- 20% for property placed in service in 2026.
- 0% for property placed in service after 2026.
While many hope for an extension of bonus depreciation, in the current environment where bonus depreciation is phased out and eventually eliminated, businesses looking to be tax efficient should consider reviewing property that is otherwise eligible for bonus depreciation for opportunities to classify the costs as immediately deductible repairs and maintenance. The phase-out and elimination of bonus depreciation is one example of how a change in rules can shift the optimal tax treatment of certain regularly incurred expenditures, and how following the same year-over-year methodology for fixed asset planning is rarely the best answer.
Statistical Sampling: Efficient Asset Review
Statistical sampling is a valuable tool in fixed asset planning. For companies with a significant number of fixed assets, statistical sampling can limit the number of assets or projects that require detailed review while still enhancing potential tax benefits. By focusing on a representative sample, businesses can more efficiently identify areas for improvement and ensure compliance with tax regulations. This approach also allows companies to manage their resources effectively while uncovering opportunities for tax savings.
Next Steps: Leveraging Detailed Asset Data
To fully capitalize on fixed asset planning opportunities, companies must gather detailed tax basis and other fixed asset data on an asset-by-asset basis. By examining this data for historical spending, BDO can help identify potential opportunities for tax savings and improved asset management, such as QIP or repair deductions. A detailed analysis can uncover areas where businesses have not fully leveraged their accounting methods.
BDO's accounting methods specialists are ready to assist businesses with identifying and implementing strategies to improve their fixed asset deductions. By leveraging our knowledge and experience, businesses can enhance their tax efficiency and financial performance. For more information, contact BDO.