As most tax professionals know, there are two depreciation systems for each type of asset: the General Depreciation System (GDS) and the Alternative Depreciation System (ADS). Most taxpayers correctly utilize GDS, however, there are times that the ADS must be utilized.
ADS Depreciation generally slows down depreciation for the taxpayer. For example, a desk is a 7-year asset under GDS and a 10-year asset under ADS as it is part of asset class 00.11 office furniture, fixtures, and equipment. Additionally, the ADS methodology requires straight-line depreciation with no bonus depreciation. Since bonus depreciation for 2018 is 100%, this becomes even more critical to understand.
While taxpayers can elect to utilize ADS, most taxpayers only use ADS if they are required to do so. ADS is required in the following circumstances:
- Listed Property used 50% or less in a qualified business
- Tangible property used predominantly outside the United States
- Any tax-exempt use property
- Any tax-exempt bond-financed property
- All property used predominantly in a farming business and placed in service in any tax year during which an election not to apply the uniform capitalization rules to certain farming costs is in effect
- Any property imported from a foreign country for which an Executive Order is in effect because the country maintains trade restrictions or engages in other discriminatory acts or companies where an election out of the 30% limitation on interest deductibility has been made.
Where we have seen the most errors is in the definition of tax-exempt use property. Many taxpayers misread this section and assume that property subject to this limitation is property leased to charities and other tax-exempt organizations. We often see property leased to state governments being depreciated utilizing the standard GDS system.
Under section 168(h)(2) property leased to “the United States, any State or political subdivision thereof, any possession of the United States, or any agency or instrumentality of any of the foregoing” is included in this portion. This means that property leased to the government is subject to ADS (with some limitations for short term leases).
Finally, it will be important to look at the effects of electing out of the 30% limitation on interest deductibility for large taxpayers. Under the Tax Cuts and Jobs Act companies with gross receipts of $25 million or more are subject to a 30% limitation on interest deductibility, unless they elect to be treated as a real estate entity. However, that election requires that all real property be taken utilizing ADS. This eliminates the ability to take bonus depreciation on Qualified Improvement Property if a technical correction is issued to the Tax Cuts and Jobs Act. Although this is called an election it is considered an Accounting Method, as such this is not something that a taxpayer can change in and out of on an annual basis. For taxpayers, with large amounts of QIP, it is critical to review the effect of bonus depreciation prior to making this election.
As noted above ADS is not as simple as many people perceive. It is critical that tax professionals and taxpayers understand when and how to utilize it. As with any of these areas please contact your McGuire Sponsel representative if you have any questions.