Everyone, including dealerships, needs to be aware and plan for how tax reform will impact their tax situation now and moving forward. The following summary highlights the top six tax reform provisions of special interest to the dealership community. This summary reflects our impressions of the legislative language. However, we anticipate additional guidance from the Treasury Department and Internal Revenue Service that may impact how these provisions are ultimately interpreted and applied. We will provide updated information and analysis as additional guidance is issued.
The top six considerations for dealerships include:
1. Interest Expense Limitation
Deductions for net interest expense are limited for businesses whose gross receipts exceed $25 million to the sum of (1) business interest income, (2) 30 percent of a business’s “adjusted taxable income,” and (3) floor plan financing interest for the tax year. Taxpayers with real property trades or businesses may elect not to apply the interest expense limitation but then become subject to depreciation limitations as discussed below.
Dealership Impact: Deductibility of Floor Plan Interest Could Be Valuable
The interest expense deduction limitations may significantly impact a number of businesses. The details regarding the computation of a taxpayer’s interest income and adjusted taxable income will be important in determining the scope of the limitation. The exception allowing the deductibility of floor plan interest is very valuable for many dealerships. However, as discussed below, the trade-off for deducting floor plan interest expense is the loss of bonus depreciation. We are hoping for additional guidance from the IRS regarding the computation of the interest expense limitation and the interaction between the floor plan financing exception and the bonus depreciation limitation to ensure that we are maximizing the available tax benefits.
2. Immediate Expensing Provisions
Bonus Depreciation and the Section 179 deduction are big considerations for dealerships. Qualifying business property acquired and placed in service after September 27, 2017, and before January 1, 2023, will qualify for 100 percent expensing with bonus depreciation phasing out in subsequent years. Qualifying property now includes both new and used property but does not include property used in a trade or business that has floor plan financing indebtedness.
The Section 179 deduction amount is increased to $1 million and the phase-out threshold for claiming the deduction is increased to $2.5 million. The definition of qualified real property for Section 179 purposes is expanded to include all qualified improvement property as well as other improvements to nonresidential real property such as roofs, HVAC property, and fire protection, alarm and security systems.
Dealership Impact: Maximize Qualified Property with a Cost Segregation Study
The increased 100 percent expensing threshold for qualifying property creates a significant opportunity for taxpayers incurring capital expenditures. Taxpayers constructing or remodeling buildings or other structures should consider a cost segregation study to maximize the amount of property qualifying for increased expensing. The statute expands the scope of the current bonus depreciation rules by including used property but also introduces a new restriction providing that bonus depreciation is not available to taxpayers with floor plan financing. At this time, the precise application of this limitation is not clear. The statutory language appears to provide several potential planning opportunities to mitigate the impact of the bonus depreciation limitation. We are currently investigating the viability of these solutions and are hopeful that we will be receiving additional guidance from the IRS soon.
Dealership Impact: Qualified Improvement Property Currently Not Eligible for Bonus Depreciation
Qualifying property for bonus depreciation includes property with a recovery period of 20 years or less. As discussed below, the Conference Report accompanying the legislation indicated that qualified improvement property was 15-year property. However, due to an oversight, the statute does not reflect a 15-year recovery period for qualified improvement property. We anticipate a technical correction addressing this issue; however, until such correction is issued, qualified improvement property is 39-year property and is not eligible for bonus depreciation. We will continue to monitor this situation and will advise if any additional guidance is received.
Dealership Impact: Section 179 May Provide Some Relief
The Section 179 expense is not limited for taxpayers with floor plan financing so may provide a valuable benefit for these taxpayers subject to limitations on bonus depreciation. Additionally, certain types of real property that will not meet the definition of qualified improvement property for bonus depreciation purposes are eligible for deduction under Section 179 under the qualified real property provisions.
3. Depreciation Recovery Periods
Qualified improvement property, as defined under existing law, is intended to be assigned a 15-year recovery period and replace all existing categories of property eligible for 15-year depreciation. However, taxpayers electing out of the interest expense limitation are required to use longer recovery periods and slower depreciation methods.
Dealership Impact: 15-Year Recovery Simplified
The elimination of the separate definitions for qualified leasehold improvement, qualified retail improvement and qualified restaurant improvement simplifies the process for determining which assets qualify for 15-year recovery and removes many of the restrictions that existed with those prior definitions.
Dealership Impact: Qualified Improvement Property Not Eligible for Bonus Depreciation
As discussed above, the Conference Committee report indicated that qualified improvement property is eligible for 15-year recovery. However, the enacted legislation does not include this provision and will require a technical correction. Until the technical corrections bill is issued, qualified improvement property is 39-year property and is not eligible for bonus depreciation. We will continue to monitor this situation and will advise if any additional guidance is received.
4. Depreciation Limitation for Luxury Cars
The depreciation limitation under Section 280F for passenger automobiles placed in service after December 31, 2017, is increased and indexed for inflation.
Dealership Impact: Claiming 100 Percent Bonus Depreciation Limits Depreciation after First Year
Due to an unforeseen interaction between the basis reduction and depreciation disallowance rules under Section 280F, taxpayers claiming 100 percent bonus depreciation will be limited to a depreciation deduction equal to the first-year depreciation cap unless the IRS provides a safe harbor method for computing the depreciation deduction for years after the first year. The IRS provided safe harbor guidance when 100 percent bonus depreciation was provided in the past and we anticipate similar guidance will be issued in this situation. We will continue to monitor this situation and will advise if any additional guidance is received.
5. Section 1031 Limitation
Non-recognition treatment for like-kind exchanges under Section 1031 is limited to exchanges of real property for most exchanges completed after December 31, 2017.
Dealership Impact: Many Leasing Businesses Negatively Impacted
Elimination of non-recognition treatment for assets other than real property will negatively impact many leasing businesses who currently rely on the like-kind exchange rules to defer recognition of income when leased assets are exchanged for new assets. These taxpayers will need to plan for an increase in their taxable income when their existing assets with deferred gain are disposed in future exchange transactions.
6. Pass-through Deductions and Section 199A
Section 199A provides a deduction for individuals, trusts and estates of 20 percent of the domestic qualified business income. Qualified business income includes income from all trades or businesses except specified businesses involving professional services.
Dealership Impact: Top Tax Rates Drop for Qualified Pass-Through Owners
Where the full 20 percent deduction is available, the top federal tax rate for pass-through owners drops from 37 percent (the new top rate for individuals) to 29.6 percent.
Dealership Impact: Rental Income May Be Qualified Income for 199A
At this time, rental income appears to be qualified business income for purposes of Section 199A but we anticipate guidance from the IRS clarifying the types of qualifying and non-qualifying income.
There are still many unanswered questions and legislation yet to come, so having a conversation with your Eide Bailly professional to learn more about how tax reform impacts future planning for your dealership is important.