The Tax Cuts and Jobs Act, enacted at the end of 2017, still is of great importance to many organizations, including dealerships. Tax reform continues to impact tax planning and strategy for dealerships across the country.
Here are the top tax reform considerations for dealerships.
You still need to care about tax reform.
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.
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.
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.
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.
We put together a webinar highlighting how tax reform is impacting the dealership industry as a whole.
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.
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.
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.
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
The regulations rely upon the traditional definition of a trade or business, which is provided for in Code section 162. This reliance raises some uncertainty in the context of rental income. For instance, a common operating structure in the dealership industry is to rent certain business real estate from a related entity. The question is whether that rental income qualifies as QBI for the 20 percent deduction.
The regulations provide a helpful rule for these situations. If the operating business and real estate entity are under common control and the real estate is used in the operating trade or business, the real estate entity is treated as part of the operating business. This means the rental income qualifies as QBI and the taxpayers owning the real estate may qualify for the 20 percent QBI deduction. It is also important to note that this real estate entity may not have identical ownership to the dealership but is likely owned by a combination of family members who may or may not have ownership in the operating entity. The regulations state that common control is achieved with direct or indirect common ownership of more than 50 percent of each entity, which means that an individual is considered to own the interest of their spouse, parents, children, and grandchildren. As a result, if a large ownership portion of a dealership operating entity has been transitioned down to the second generation of the family, but the real estate entity is still owned by the parents (first generation), the rental income to the parents may still be considered QBI.
Once income is determined to be QBI, several limits can result in a reduced or disallowed deduction. For example, the QBI deduction cannot exceed 50 percent of total wages paid as part of a business. For those businesses without substantial wages, an alternative test provides that the QBI deduction cannot exceed 25 percent of wages plus 2.5 percent of the unadjusted basis immediately after acquisition (UBIA) of certain qualified property.
A potential issue raised by these limitations is the use of related entities to conduct payroll and other back-office functions. For instance, a group of dealerships under common control may use a single payroll entity to pay wages for all employees. Each of those dealerships technically has no direct employees, and there was some concern that income from those dealerships would be limited by the W-2 wage limitation.
Fortunately, the regulations allow businesses to make use of certain W-2 wages paid by another entity as long as the business is considered the “common law employer,” even if that business did not technically issue the W-2. In the example above, this means that each of the dealerships (assuming they are the common law employer) would be allocated a portion of the wage expense paid by the payroll entity for purposes of the W-2 wage limitation. Additionally, the regulations allow wages paid by certain third-party payors (such as professional employer organizations) to count towards the W-2 wage limitation as long as the wages are paid to “common law” employees of the business generating QBI.
Dealership Impact: Aggregation Rule
The regulations also provide a new aggregation rule to allow taxpayers to group various related businesses together for purposes of the section 199A deduction. Under this new rule, aggregation of multiple businesses is allowed, but not required, if the following requirements are met:
Taxpayers may find it beneficial to aggregate businesses for several reasons, including administrative efficiencies and allowing related businesses to share W-2 wages and UBIA for purposes of the various limitation tests. Aggregating also allows businesses the ability to net together income and loss for purposes of the overall section 199A deduction.
The Impact of Tax Reform on Dealerships
Dealerships continue to see benefit from various aspects of tax reform. It’s important to understand how these will impact your dealership and its potential tax burden.
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