Can equipment purchased for rental properties in qualified real estate businesses be immediately depreciated under section 179 in California? Turbotax doesn't let me.

[thuyh1121]

Turbotax shows the asset as depreciating over 5 years in California. If I try to edit, it says "no adjustments are necessary." I know that California's limits and thresholds are different, but they should not apply. California seems to have some differences in what assets qualify, but I can't find a clear source for this. Is there a good reason Turbotax is stopping me?

And just in case I'm totally off here: I purchased new electrical panels for a small apartment building that I own and operate. It *seems* like that should qualify under Section 179 federally, but please let me know if that seems wrong. 

[ColeenD3]

You wrote, " It *seems* like that should qualify under Section 179 federally, but please let me know if that seems wrong." Federally, there is no Section 179 for residential rental property.

Please see this answer from PaulaM.

To qualify for the section 179 deduction, your property must have been acquired for use in your trade or business. 

Property you acquire only for the production of income, such as investment property, rental property (if renting property is not your trade or business), and property that produces royalties, does not qualify. 

But the asset does qualify for the Special Depreciation Allowance.

See page 17 of IRS pub below.

Section 179

CA discusses conformity on Pages 8 and 9 of the following link.

 Depreciation

[Carl]

Basically, assets used for the production of passive income (namely, rental assets) do not qualify for SEC 179. But some most certainly can qualify for the Special Depreciation Allowance.

I purchased new electrical panels for a small apartment building

Since those become "a physical part of" the structure they get classified under MACRS as Residential Rental Real Estate. Regardless of their cost, they have to be depreciated over 27.5 years. (At least, per what I see/read in the program)

[thuyh1121]

Based on https://www.nolo.com/legal-encyclopedia/is-your-rental-activity-business-investment.html, I believe my rental activity meets the "regularly and continuously" requirements to qualify as a business. How would that change things?

[Carl]

I myself don't use non-IRS sources to make such determinations. Take a look at IRS Publication 527, page 12 starting at the bottom of the middle column here , and IRS Pub 334 Chapter 5 page 21, section for "Real Estate Rents" here I've copied what I consider the relevant portions of 527 to your query with the specific part in bold print. This will help you make a more educated determination, and easier to deal with an IRS challenge if it happens.

Providing substantial services.

If you provide substantial services that are primarily for your tenant's convenience, such as regular cleaning, changing linen, or maid service, you report your rental income and expenses on Schedule C. Use Form 1065, U.S. Return of Partnership Income, if your rental activity is a partnership (including a partnership with your spouse unless it is a qualified joint venture). Substantial services don’t include the furnishing of heat and light, cleaning of public areas, trash collection, etc. For more information, see Pub. 334, Tax Guide for Small Business. Also, you may have to pay self-employment tax on your rental income using Schedule SE (Form 1040), Self- Employment Tax. For a discussion of “substantial services,” see Real Estate Rents in chapter 5 of Pub. 334

[thuyh1121 · Accepted solution]

Those passages you linked do not appear to have anything to do with Section 179. The text of Section 179 itself (https://www.law.cornell.edu/uscode/text/26/179) does not define "active conduct of a trade or business." Neither does Publication 946 (https://www.irs.gov/publications/p946). So while I'd love to rely on official sources, we're kind of out of luck.

The AICP's Tax Adviser publication very explicitly explains the lack of connection between self-employment tax (your references) and section 179 (https://www.thetaxadviser.com/issues/2020/oct/maze-real-estate-rentals.html#fn_38). It states:

"Material participation is not required for the active trade or business requirement and neither is significant participation. These terms focus mostly on hours of involvement by the taxpayer. "Active conduct" is a low standard. Being involved in making decisions should suffice."

Section 179 used to specifically exclude "real property used for lodging" but that restriction was removed from 179d.1.C by the Tax Cuts and Jobs Act. It looks like California doesn't accept this change (along with many others in the Act).

So if we can conclude that my property is a business for the purposes of Section 179, my one remaining question is if electrical panels are eligible property.

Edit: It seems pretty clear that the IRS considers electrical wiring and other installations necessary to transmit electricity as part of the building itself, making it ineligible for Sec. 179.

[Carl]

@thuyh1121 Your first post in this thread asks about the "trade or business" determination. Nothing about the SEC179.

Can't speak for CA. At the federal level, residential rental property is not eligible for SEC179 (generally), but some rental assets can qualify for the special depreciation allowance.  That's a separate thing from determining if a rental activity qualifies as a trade or business.

As for the "how would that change things", here's the monetary difference on the tax front.

With a trade or business, not only is the taxable income subject to the "normal" tax, but it's also subject to the additional 15.3% self-employment tax. Not a "bad" thing really, because the SE tax is something like 3.2% of the 15.3% (give or take) of the employer's side of the Medicare tax, and the remaining the employer's share of the Social Security tax. So it a sense, the SE tax is like "Paying your future self" on the social security side.

Additionally, with SCH C income, that increases your allowed maximum contribution to a qualified tax deferred retirement account. But only if you have an actual taxable profit. Where as passive rental income can not be used in determining one's yearly maximum contribution, and is not used in determining the amount of social security one is eligible to receive at retirement age.

So on the SCH E passive side, the pros are no SE taxes. Cons are, can't be used in determining max retirement contributions, or amount of SS payments at retirement age.

On the SCH C side, the pros are, you can include the taxable profit when determining max contributions to a qualified retirement account. Cons are, you pay the additional 15.3% SE tax on the actual taxable profit.

Keep in mind too, that for most residential rental property owners, actually showing a taxable profit on paper at tax filing time isn't all that common. For those that can and do report rental activity on SCH C, even having to depreciate the property over 39 or 40 years as business property, (vs 27.5 years on SCH E) doesn't always keep the yearly depreciation deduction low enough, so that they actually show an actual profit on the SCH C.

For the ones I hear about that do qualify to report their rental activity on SCH C, that rental activity is but one part of their SCH C business. For example, most realtors operate on a commission that is considered self-employment income. So they're reporting more than just the rental income on SCH C, and therefore have no issue showing a taxable profit on the business.

[thuyh1121]

Actually, my first post asked, "Can equipment purchased for rental properties in qualified real estate businesses be immediately depreciated under section 179 in California?"

but I did subsequently ask about "trade or business" determination, and I appreciate the thoughtful response.

[Carl]

I just did a quick search and found https://www.ftb.ca.gov/forms/2018/18-3885-instructions.html

There it states under "California law conforms to federal law for the following" and one item listed there is "The additional first-year depreciation, or the election to expense the cost of the property as provided in IRC Section 179, with modification." 

Under that is "California law does not conform to federal law for the following" and listed there is "The expanded definition of IRS Section 179 property...." and "the enhanced IRC Section 179 expensing election"

Now on the federal side, in the past, Section 179 could not be used to deduct personal property used in residential rental property. However, the Tax Cuts and Jobs Act eliminated this restriction starting in 2018. This means that landlords can now use Section 179 to deduct the cost of personal property items they purchase for use inside rental units—for example, kitchen appliances, carpets, drapes, or blinds. So I interpret this to be one of the "enhancements" that CA does not conform to.  Weather my interpretation is correct or not, I honestly can't say.