Page 391 - TaxAdviser_2022

TAX CLINIC

depreciation adjustments in there are a number of common circum- placed in service, such as roofs, HVAC,
excess of straight line for peri- stances where gains on the disposition fire protection and alarm systems, and
ods after December 31, 1963, of real property could be subject to security systems (id. at (e)). To the extent
computed under paragraph recapture of prior depreciation, in whole that Sec. 179 deductions are claimed
(b)(1) of this section. or part, as ordinary income. on such property, the property becomes
One common depreciation recapture subject to the recapture rules under Sec.
While Sec. 1250 only requires ad- example involves qualified improvement 1245 instead of Sec. 1250.
ditional depreciation to be recaptured as property (QIP). QIP includes certain It is important for taxpayers to prop-
ordinary income, Sec. 1(h)(1)(E) sub- improvements to the interior portion of erly classify the property as Sec. 1245
jects unrecaptured Sec. 1250 gain to a nonresidential real property (Sec. 168(e) upon disposition since any gain resulting
maximum tax rate of 25%. Unrecaptured (6)). QIP is 15-year property subject to from depreciation deductions, including
Sec. 1250 gain is the long-term capital the straight-line method of depreciation the Sec. 179 deductions, will be rechar-
gain that would be treated as ordinary but is eligible for bonus depreciation acterized as ordinary income, as opposed
income under Sec. 1250 if all deprecia- under Sec. 168(k). Since bonus deprecia- to only the additional depreciation being
tion was treated as additional deprecia- tion allows for deductions in excess of recharacterized under Sec. 1250. Assume
tion (Sec. 1(h)(6)(A)(i)). those allowed under the straight-line that in the earlier example, the taxpayer
method, such excess would be consid- had taken $1,500 of Sec. 179 deductions
Example 2: In year 2, Partnership ered additional depreciation for purposes instead of $1,500 of bonus depreciation.
AB (described in Example 1) buys of Sec. 1250. The additional deprecia- After year 3 the taxpayer would have up
Sec. 1250 property for $200. In a tion would be reduced going forward by to $1,500 of ordinary income recapture
subsequent year, when the property the amount of straight-line depreciation under Sec. 1245 as opposed to having
has an adjusted basis of $100, it is the taxpayer would have been allowed $1,200 of potential ordinary income
sold for $250, resulting in a gain of for such year. recapture under Sec. 1250. In the case
$150. At the time of the sale, ad- For example, consider a taxpayer that of the Sec. 179 expense deduction, time
ditional depreciation is $20. Partner- acquired $1,500 of QIP for which it will not erase the ordinary income re-
ship AB recognizes Sec. 1250 gain claimed bonus depreciation in the year capture taint.
of $20, the lesser of the additional placed in service. The taxpayer would Land improvements provide the last
depreciation ($20) or gain on the have been allowed $100 of straight-line depreciation recapture example to look
property ($150). The remaining gain depreciation per year if bonus deprecia- at. Land improvements, unless otherwise
of $130 would be broken down as: tion had not been claimed. Therefore, specified, have a 15-year modified accel-
(1) $80 of unrecaptured Sec. 1250 the additional depreciation after each erated cost recovery system (MACRS)
gain ($100 of depreciation less $20 of year would be calculated as the deprecia- recovery period and are eligible for
Sec. 1250 gain); and (2) $50 of capi- tion taken of $1,500 less the product bonus depreciation, as QIP is. However,
tal gain pursuant to Sec. 1231. of $100 times the number of years of their general depreciation method is not
straight-line deprecation. After year 3 the straight-line method of depreciation.
Now that the basics of Secs. 1245 the additional depreciation would be Instead, land improvements are subject
and 1250 have been explained, this item $1,200 ($1,500 − [$100 × 3]), assum- to the 150% declining-balance method
will discuss some aspects of real property ing the full-year convention applied to under Secs. 168(b)(3) and 168(b)(2)(A).
depreciation recapture in more detail the situation. The 150% declining-balance method is
and then look at situations involving the Another depreciation recapture an accelerated depreciation method that
application of depreciation recapture example involves qualified Sec. 179 would create additional depreciation in
rules in the partnership context. real property. Depreciable real property the early years of the asset’s life. This
does not generally qualify for Sec. 179 additional depreciation amount would
Real property situations deductions. However, the definition of start being reduced in year 6 but not
Depreciable real property is often, but Sec. 179 property has been expanded be fully eliminated until after the asset
not always, depreciated utilizing the to include qualified real property (Sec. was fully depreciated after 15 years of
straight-line method. In these situations, 179(d)(1)(B)(ii)). Qualified real prop- depreciable service. For example, if the
Sec. 1250 would not be applicable since erty for this purpose includes QIP and taxpayer placed a 15-year land improve-
there would be no additional deprecia- certain improvements to nonresidential ment in service in year 1 using the 150%
tion to recapture, but the unrecaptured real property placed in service after the declining-balance method, the addition-
Sec. 1250 gain rules may apply. However, nonresidential real property was first al depreciation at different times would

8 August 2022 The Tax Adviser