By Matthew A. Brown, CPA; Natalie A. Frenier, CPA; and Joseph A. Magyar, CPA
At the end of 2017, President Donald Trump signed into law some of the most comprehensive tax changes enacted in decades, known as the Tax Cuts and Jobs Act. With the law’s special focus on the taxation of businesses, it’s important for auto dealers to understand the changes and potential implications.
This is the second in a series addressing areas dealers should be aware of to take advantage of the new tax laws. The first addressed pass-through businesses and C-corp structures under the new law.
The issues may be relevant to consider as extended 2017 returns are filed. More significantly, these matters will be important for 2018 and moving forward. There are many details that will require regulatory or other IRS guidance as the law takes full effect. We expect much of this guidance will begin to be released in the second half of 2018 thus dealers should keep in close contact with their tax advisors.
Prepare to Maximize the Depreciation Deduction
The new tax law includes significant changes to depreciation and cost recovery rules that are applicable to all business types. Bonus depreciation is expanded from 50 to 100 percent deduction starting after Sept. 27, 2017. The deduction now includes used property in addition to new personal property and land improvements. Because of a congressional drafting error, qualified improvement property is eligible for 50 percent bonus depreciation only if placed in service by Dec. 31, 2017, and is ineligible for bonus depreciation if placed in service on or after Jan. 1, 2018. The 50 percent bonus deduction continues to apply to new assets that were acquired and placed in service before Sept. 28, 2017, or placed in service after Sept. 27, 2017, but acquired pursuant to a written binding contract in effect before that date. The 100 percent bonus phases out from 2023 to 2027.
Starting on Jan. 1, 2018, dealerships with floor plan financing are not eligible for bonus depreciation. This exchange of the full deductibility of floor plan interest for bonus depreciation should be of significant value for most dealerships. The interest expense limitation application to floor plan financing could have become especially burdensome for dealers – and perhaps even catastrophic for some dealers – if economic cycles resulted in higher interest rates and reduced profitability.
As dealers transitioned from 50 percent to 100 percent bonus depreciation, the end of 2017 provided a window at year-end for dealers to make acquisitions of equipment or other assets that would benefit from the 100 percent expensing. Many dealers may have bought additional equipment at the end of 2017, or they may have accelerated other purchases originally planned for 2018, to take advantage of the 100 percent bonus depreciation.
Some dealers might have felt that expanding their service loaner fleet was a good opportunity at that time. Dealers should be cautious, however, because if those service loaners were originally purchased before Sept. 28, 2017, they would qualify for only 50 percent bonus depreciation because the dealer would have acquired those assets into inventory before Sept. 28.
In addition to changes to depreciation and cost recovery, the Section 179 expense allowance increases to $1 million, and the phaseout threshold increases to $2.5 million. The new rule also expands the definition of qualified real property eligible for Section 179 expensing to include any of the following improvements to nonresidential real property made after the date such property was first placed in service: roofs, heating, ventilation, air conditioning, fire protection and alarm systems, and security systems.
Dealers should note that the expansion of Section 179 expensing is available to dealership entities with floor plan indebtedness. The limitation on bonus depreciation does not apply to Section 179 because it is a separate provision.
Dealers also will want to consider if the interest deduction limitation will affect their real estate entities. If so, the real estate entity may make an election to forego the interest deduction limitation in exchange for using the alternative depreciation system asset lives of 40 and 20 years, which are ineligible for bonus depreciation.
Other significant changes in this area include an increase in depreciation limits for luxury automobiles. The new limits are:
- Year one = $10,000
- Year two = $16,000
- Year three = $9,600
- Year four and after = $5,750
In addition, like-kind exchanges now are limited to real property. Business and investment real estate has long been the most common dealership-related asset used for like-kind exchanges. Like-kind exchange treatment will continue to be available for these real estate assets but no other types of assets.
Monitor Interest Expense Limitation
Starting in 2018, business interest expense will be limited to 30 percent of adjusted taxable income. Dealership floor plan interest remains fully deductible; however, other dealership business interest remains subject to the limitation. This limited deduction might apply to mortgage interest on property held within the dealership entity, dealership acquisition loan interest, and other types of working capital or loans within the dealership business. Other businesses, including real estate entities, will be subject to the 30 percent interest limit as well.
Through 2021, for purposes of the 30 percent test, adjusted taxable income will be calculated similar to earnings before interest, taxes, depreciation, and amortization. Beginning in 2022, it will be calculated similar to earnings before interest and taxes. Of particular note to dealers in this area is that it appears that the interest add-back that could determine adjusted taxable income may include floor plan interest. This creates a “double-dipping” benefit for dealers. However, dealers should beware that this change may have been a drafting oversight that may be corrected in the future.
According to the new rules, if the interest limitation does restrict the deduction, the excess interest would carry forward indefinitely. The limitation generally applies on an entity-by-entity basis, which does not allow an excess from one business to shelter the disallowed amount from another related business. A consolidated group, or C-corp, however, likely is treated as one entity. The new interest expense limitation rules do not apply to the following entities:
- Real estate trades or businesses that elect to take depreciation under the alternative depreciation system in lieu of bonus depreciation
- Businesses with average gross receipts of less than $25 million for the prior three years (attribution rules apply in this case)
Crowe is a global public accounting, technology, and consulting firm. Joe Magyar is a partner with Crowe and can be reached at 1-813-2092435 or email@example.com. Matthew Brown can be reached at 1-954-202-8535 or firstname.lastname@example.org. Natalie Frenier can be reached at 1-614-469-1279 or email@example.com.