Historically when business owners in the restaurant, hotel, or food distribution industries conduct a major buildout or refurbishment project, they can take advantage of major tax depreciation incentives. The new Tax Cuts and Jobs Act was intended to expand on these depreciation incentives, however a technical error in the new law regarding qualified improvement property could hinder what business owners are able to deduct.
Under the new tax law, fixed assets that are placed into service after September 27, 2017, are now eligible for 100% bonus depreciation, compared to 50% bonus depreciation under the old law. 100% bonus depreciation enables business owners to deduct the full cost of the fixed asset in the year it is placed into service.
The new law also consolidates items considered qualified leasehold improvement property with qualified improvement property. Qualified improvement property are enhancements to the interior portion of a building that’s considered nonresident property. Qualified leasehold improvement property acted similar to qualified improvement property, except the enhancements were pursuant to lease and had to be placed in service more than three years after the date the building was first placed into service.
Under the old law, qualified improvement property was depreciated over 39 years and was eligible for 50% bonus depreciation, while qualified leasehold improvements were depreciated over 15 years and was eligible for 50% bonus depreciation. The new law states that only items with a depreciable recovery period of 20 years or less are eligible for the 100% bonus deduction.
While it was intended for qualified improvement property to have a 15 year recovery, enhancements to the interior portions of buildings that get completed and placed into service by restaurant, hotel, and food distributor owners are now technically not eligible for bonus depreciation.
Below is an illustration of how the depreciation deductions would work under both the old tax and new tax law:
ABC Restaurant, which leases its restaurant space, completed a major renovation project that included $500,000 of qualified improvement property.
Old Tax Law
ABC Restaurant would have been able to deduct $250,000 in first year, or 50% bonus depreciation on what would been considered the qualified leasehold improvements. The remaining $250,000 of qualified leasehold improvements is depreciated over 15 years. ABC Restaurant would claim a first year depreciation deduction of $12,500.
Total tax deductions: $262,500
New Tax Law
ABC Restaurant cannot claim any bonus depreciation on the qualified improvement property. The $500,000 of qualified improvements is depreciated over 39 years. ABC Restaurant would only claim a first year depreciation deduction of $12,820
Total tax deductions: $12,820
New Tax Law with Technical Correction
Assuming a technical correction is made to the tax law, the qualified improvement property would have a 15 year life for depreciation purposes. In this case, ABC Restaurant would be able to deduct $500,000 in first year 100% bonus depreciation.
Total tax deductions: $500,000
Until a technical correction is issued to the tax law, restaurant, hotel, and food distribution owners may not be able to claim accelerated tax deductions for qualified improvements that are placed into service. This could be a major issue because qualified improvements are generally the biggest expenditures that come with completing a major renovation project and have historically provided large tax incentives. Restaurant, hotel, and food distributions owners should reach out to their tax advisor to discuss how this could impact their business moving forward.
Our tax specialists are available for consultation on this and other business management topics for restaurants and hotels. Please contact our hospitality tax advisors or Aaron Boker at 301.231.6200 for more information.