To call 2020 a challenging year for the hospitality industry would be an understatement. With indoor eating closed or severely restricted across the country, there were many unanticipated costs to quickly create or expand outdoor seating, take-out, and drive-through options. Then, as the restrictions began to lift, restaurants of all sizes had to pay much more to keep returning customers safe and comfortable.
These expenses included improvements to old – or installations of new – air filtering or ventilation systems (e.g. HVAC); Purchase of special equipment; Installation of physical barriers; Delivery of personal protective equipment (PPE) and more.
One small benefit is that these expenses also created significant tax deferral opportunities that can help reduce the resulting financial burdens on restaurants. Here’s what you need to know about what purchases can lead to big tax breaks:
When a restaurant purchases equipment, furniture, or household appliances, or makes improvements to leased or owned property, it is generally permissible to deduct the cost of those assets over the useful life allocated by the Internal Revenue Service. This cost recovery is achieved through the annual depreciation expense reported in the company’s annual income tax return.
The Internal Revenue Code gives companies the ability to expedite these deductions by taking additional first year depreciation (“bonus depreciation”) on qualifying depreciable property. Bonus write-offs are possible in some – but not all – countries. This can create significant tax planning opportunities for restaurants.
Photo: Anton Rayetskyy
Prior to the Tax Cut and Jobs Act (TCJA), passed in 2017 that made several favorable changes to tax depreciation rules, a restaurant could generally claim a 50% bonus deduction in connection with purchasing qualifying new property. Examples of such assets were machinery, appliances, furniture, and qualified improvement traits (QIP, defined below).
A 50% bonus meant a company could immediately spend 50% of the cost of those assets in the first year of operation. TCJA has significantly expanded the rules for bonus write-offs and increased the deduction of qualifying properties to 100%.
Tax law offers other ways to expedite deductions related to certain acquisitions and repairs. However, this article focuses on opportunities that arise from bonus depreciation.
What is eligible for a bonus write-off?
Many restaurant expenses, including tenant fixtures and upgrades, are eligible for a bonus write-off. Qualifying property includes depreciable assets with a useful life of 20 years or less and typically includes the assets listed above.
Photo: Richard Shevak
One category of real estate for which bonus amortization is possible is Qualified Improvement Property (QIP). QIP is an improvement to the interior of a commercial building that was made after the building was first put into operation. It does not include work on an elevator or escalator, no building expansion or work on the “structural framework” of the building.
Congress intended that QIP fit into the category of assets eligible for bonus write-off. However, an editorial error in the TCJA resulted in it being treated as a 39 year old property and therefore not eligible for a bonus write-off.
Fortunately, the Coronavirus Aid, Aid and Economic Security (CARES) Act was passed, which was passed in March last year in response to the COVID-19 pandemicfinally corrected the editorial error to make QIP a 15 year property and get a 100% bonus write-off. In other words, it has restored the TCJA’s original intent to allow the full withdrawal of essentially all depreciable business goods normally purchased from restaurants.
What does this mean for restaurants?
Bonus write-off means potential additional tax deductions and the immediate overhead of the costs restaurants had to incur navigating disruptions related to COVID-19. Although the money has been spent, there are ways to ease that financial burden by speeding up tax deductions. Below we cover some general expenses restaurants have incurred and will continue to incur and discuss their deductibility.
- Leasehold improvements and interior renovations (including HVAC): As mentioned above, QIP is an improvement on the interior part of a commercial building that comes into operation after the building itself. For example, interior improvements could include the cost of upgrading interior HVAC components to better filter the air in the restaurant. External components such as roof units would not be a QIP. QIP can include a variety of other interior improvements such as: B. Interior lighting and electrical upgrades, construction of interior walls, floors, ceiling tiles, and bathroom upgrades.
- Construction of outdoor seating areas: This cost can include the construction of plastic, material, or wooden enclosures; Purchase of outdoor lighting equipment; and installation of mounted or freestanding heating lamps.
Movable items such as furniture and equipment generally have a shorter useful life, making them eligible for a bonus depreciation allowance. Because, in most cases, these outdoor tents or enclosures are built on sidewalks and / or streets and are not permanently attached to a building or property, they are movable and may be considered a qualifying asset. Therefore, the cost of building exterior enclosures, including installing lighting and heating systems, could be eligible for a 100% bonus write-off.
Careful analysis should be carried out if the outdoor area, including all electrical components, is designed as a continuation and permanent connection with a restaurant. This is likely to be considered a 39 year old property and is not eligible for bonus treatment.
- Physical barriers to indoor and outdoor seating: Similar to moveable external enclosures, physical barriers that are placed to separate tables from customers can have a useful life of less than 20 years and therefore receive a 100% bonus write-off.
- Personal protective equipment (PPE)): Examples of these costs include masks, face shields, gloves, social distancing signs, hand sanitizer with or without a stand, and portable thermometers. In most cases, these expenses are not considered to be assets with a useful life of more than one year and therefore do not need to be capitalized and depreciated. Instead, they could be viewed as materials and supplies deductible as they arise.
Note, however, that depreciable assets that do not qualify for the additional deduction, regardless of 100% bonus eligibility, will continue to incur an annual depreciation expense spread over their assigned useful life.
It’s also important to note that not all states follow federal rules. Contact your tax service provider for more information about the government rules that apply to you.
As you can see, these rules can get complicated and be different for each restaurant. However, the potential tax benefits can be significant. Therefore, contact your tax advisor to determine the correct and most beneficial treatment in your situation.
Anton Rayetsskyy is a Senior Tax Manager in CohnReznick’s New York office and a member of the company’s Hospitality Industry Practice. Richard Shevak is a principal in CohnReznick’s national tax practice and leads the firm’s property, plant and equipment tax and accounting practice practice.
This article does not necessarily reflect the opinions of the editors or the management of Nation’s Restaurant News and Restaurant Hospitality.