Tax Reform Update: Pass-through deduction, bonus depreciation guidance released

In early August the IRS and U.S. Treasury Department issued proposed guidance for pass-through businesses and bonus depreciation.

Pass-through Deduction Guidance

This guidance relates to the 20% deduction for pass-through businesses and can be found here. The IRS also released a frequently asked questions document (FAQ) and proposed revenue procedures for calculating W-2 wages for determining the deduction.

The Tax Cuts and Jobs Act (TCJA) that was signed into law in December provides a deduction for pass-through businesses of up to 20% of their qualified business income. The 20% deduction is limited in part by (1) 50% of the W-2 wages with respect to the qualified trade or business (the “W-2 Limitation”), or (2) the sum of 25% of the W-2 wages with respect to the qualified trade or business plus 2.5% of the unadjusted basis immediately after acquisition (UBIA) of all qualified property.

REIT dividends and qualified publicly traded partnership (PTP) income also qualify for the 20% deduction. These sources are not limited by W-2 wages or the UBIA of qualified property.

The proposed regulations:

• Detail select service business income that is not eligible for the deduction for taxpayers with income above the $315,000/$157,000 threshold. These include law, architecture, engineering, accounting and consulting (among others).  
  • Real estate brokers and property managers are excluded from the list, making them eligible to receive the deduction.
• Lay out “aggregation rules” for filers with pass-through income from multiple sources.
  • These require the same group of owners must own a majority stake of each business in the aggregated group. Owners are allowed to apply family attribution rules to measure their ownership stake, and minority owners may rely on the ownership of the entire group to qualify for aggregation.
  • Allow a de minimis exception for businesses earning only a small percentage of ineligible service income.
• Establish anti-abuse safeguards to prevent tax avoidance schemes. 

Bonus Depreciation Guidance

The IRS and U.S. Treasury Department guidance on bonus depreciation, § 168(k) of the tax code can be found here.

The TCJA  increased the first-year depreciation deduction from 50 to 100% for qualified property acquired and placed in service after September 27, 2017. Bonus depreciation is not available, however, to businesses that elect out of the new limitation on deducting business interest, which may include many real estate developers.

The law also combined several separate categories of property improvements – leasehold, restaurant, and retail – under a new definition called “qualified improvement property” (QIP). QIPs were intended to be depreciated over 15 years. Due to a drafting mistake, however, these improvements must be depreciated over 39 years, much longer than their economic life.

Although the regulations define qualified improvement property (QIP), they don’t address the statutory problem of QIP not being assigned its intended 15-year life. ICSC is lobbying Congress to address this oversight, and we are hopeful that a retroactive fix can be passed by the end of the year.