Dealers are navigating unprecedented market conditions, and most are experiencing a higher bottom line and healthier cash flow. Many dealers delayed investing in major capital improvements or significant purchases of personal property during the pandemic due to the volatile circumstances and concerns around potential shutdowns. Now that we’ve entered what most consider the post-pandemic era, dealers are in a position to put their working capital to good use.

As dealers contemplate significant capital improvement projects, such as a facility image upgrade or electric vehicle infrastructure, they should work with their tax advisors on how to maximize the tax benefit of placing these projects in service. Changes to the business interest expense limitation calculation for taxable years beginning after January 1, 2022, may have a substantial impact on the amount of depreciation expense immediately available for dealers when placing improvements in service.

As a refresher, the business interest expense limitation was introduced through the 2017 Tax Cuts and Jobs Act. A taxpayer’s business interest expense deduction is limited to the sum of business interest income, floorplan financing interest and 30% of adjusted taxable income (ATI). For taxable years beginning prior to January 1, 2022, depreciation, amortization and depletion were added back to taxable income when computing adjusted taxable income. Thus, accelerated depreciation has had no bearing on the deductible business interest expense. Beginning in 2022, ATI will include deductions for depreciation and amortization.

Most if not all dealerships use floorplan financing. For these dealers, an exception was created to allow them to fully deduct their floorplan interest expense if they are unable to do so when applying the standard 30% test. If the dealer can deduct all of their business interest expense without using the floorplan interest exception, bonus depreciation can be utilized. However, if a floor-planning dealer is unable to fully deduct their business interest expense (including floorplan interest) when applying the 30% test, bonus depreciation is unavailable for that taxable year. If a floor planning dealership makes a significant depreciable investment, they are now more likely to be limited on the availability of bonus depreciation beginning in 2022.

Despite these changes, one can maximize the tax benefits of capital improvements. If a related entity owns the real estate and the lease is structured to pay for and capitalize the improvements, it may be advantageous for that to happen. With no floorplan interest expense, they would be allowed to deduct bonus depreciation on eligible property. The real estate entity may experience a business interest limitation from the accelerated depreciation; however, the benefits may outweigh the limitation.

If the real estate is owned by an unrelated third party and the dealership capitalizes the improvements, there is still an opportunity to take advantage of accelerated depreciation but to a potentially lesser degree. Taxpayers can elect out of bonus depreciation by class of property, which means a taxpayer could potentially take bonus depreciation on 15-year property and elect out of bonus depreciation on 5- and 7-year property.

Also, don’t forget the Tangible Property Regulations (TPRs)! Depending on the scope of the project, a portion may be considered a “refresh” under rules that would treat it as a repair or maintenance expenditure, rather than a capital asset, a determination based on the facts and circumstances of the specific project.

While the changes to the business interest expense limitation may impact which entity capitalizes improvements or ultimately how much depreciation can be taken in year one, with proper tax planning there are ways to maximize the benefit.

Consult your AutoCPAGroup member for guidance in navigating tax strategies. ✍