The new law increases and extends "Bonus Depreciation" provisions on real property, including operating real estate assets owned by companies. Specifically, the Act provides an additional first-year depreciation deduction equal to 50% of the adjusted basis of qualified property. It is a 66.6% increase from the 30% first-year depreciation deduction that has been in place since the Job Creation and Worker Assistance Act of 2002 was passed in March of last year.
"I thought the 30% first-year depreciation deduction would have triggered more investment; but it wasn't really noticeable," Michael Whalen, national director for the construction division of Ernst & Young's Real Estate Advisory, tells GlobeSt.com. "Hopefully this will provide the necessary incentive for those companies that have put off making a decision."
The path to accelerated bonus depreciation requires completion of a cost segregation study, which identifies and segregates certain assets that qualify as shorter-lived property, especially for U.S. Federal Tax purposes. With the new Acts, these properties now qualify for not only the traditional benefits of cost segregation, but also an additional 50% deduction in the first year -- while the remaining basis (after the Bonus Depreciation allowance) is depreciated over the applicable recovery period.
Whalen says this can be a significant advantage to both corporations in seeking maximum benefits from their operating real estate, and for real estate investors in income-producing properties. In detailing its advisory, Ernst & Young gives the example of a taxpayer that constructs a qualified $100 million production facility where $20 million of the construction costs (in addition to direct purchase production machinery) are segregated as seven-year property.
"Before Bonus Depreciation, the taxpayer might receive a $2.9 million deduction in the first year (half-year convention) for the 7-year property," states the advisory. "With Bonus Depreciation, the taxpayer might receive a $10 million deduction (50% x $20 million), plus the normal deduction for the remaining balance - in this case $1.4 million. Assuming a 35% tax rate, this taxpayer's first year tax bill was reduced by nearly $3 million. What's more, this example excludes normal depreciation for the remaining $80 million."
To qualify for a 50% Bonus Depreciation deduction under the Act, the property must have a construction start date after May 5, 2003, and be placed in service before January 1, 2005, with no binding written contract for the acquisition in effect before May 6, 2003. "Placed in service" generally requires completion of construction, but there are instances where partial completion may be adequate, and where the time period may be extended to January 1, 2006.
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