Tax Treatment of Structures Under Expensing
May 24, 2017
The draft House Republican tax reform plan would permit businesses to immediately expense (write-off the cost in the first year) capital outlays instead of reporting the cost for tax purposes over lengthy depreciation schedules. The expensing would apply to buildings and other structures as well as to equipment. (The partial expensing provisions that have been in effect for some recent years were restricted to equipment.) The addition of buildings and other structures to the provision is important, because structures (plant, office buildings, commercial real estate, residential rental properties, agricultural structures, etc.) constitute just over 70 percent of the private sector capital stock, versus just under 30 percent for equipment. Structures deliver roughly 70 percent of the contribution of private capital to the to the GDP.
Economic and Budget Estimates
We used the Tax Foundation Taxes and Growth Model (TAG) to estimate the growth and revenue effects of full expensing for all depreciable assets (structures, equipment) and of the expensing of structures alone. (See table.) Expensing for all assets would lift the GDP by about 4.8 percent over a decade. Of that growth, about 3.5 percent would be due to the inclusion of structures in the expensing allowance. Of the projected 14.4 percent increase in the private capital stock, structures would account for 10.3%. Structures would contribute similarly, over 70 percent of the total, to the projected wage and job gains, and to the projected revenue gains due to economic growth generated by the additional capital formation.
In the long run, our model finds that expensing would reduce tax revenue by $62 billion a year after fully phased in, but would result in higher federal revenue of about $112 billion dollars a year, after taking growth into account. (These numbers are in terms of 2016 dollars and based on the size of the 2016 economy). The portion of the provision due to structures would involve a $44 billion revenue loss before growth, and an $83 billion revenue gain after taking growth into account.
|Full Expensing for All Assets||Expensing for Structures Only|
|GDP (billions of 2016 $)||$904||$654|
|Private business GDP||5.0%||3.6%|
|Private business stocks (equipment, structures, etc.)||14.4%||10.3%|
|Private business hours of work||0.9%||0.7%|
|Full-time equivalent jobs (in thousands)||912||672|
|Static federal revenue estimate (GDP assumed constant)||-$62||-$44|
|Dynamic federal revenue estimate (with GDP change)||$112||$83|
Operating Losses After Big Outlays
The purchase of a large structures can be a big expense for a business in the year it is done. In some cases, if other revenues were not large enough to absorb the deduction, it would result in a net operating loss (NOL) for several years. Under current law, the unused deduction may be carried back two years, or carried forward for up to twenty years, after which it would be lost. These rules penalize “lumpy” investments by delaying of cancelling the tax benefits. The House Republican plan fixes these problems by ending the fifteen-year limit on the carry-forward, and by augmenting any delayed deduction by the time value of money (in effect, paying interest on the delayed deduction). Doing so maintains the full present value of the write-off, even if it must be deferred. (This would be calculated as inflation plus a normal three percent return. For example, if inflation were two percent, the annual adjustment would be five percent, and a $100 unused deduction left over from year one would be increased to $105 for use in year two, and so on over time.) This approach to delayed write-offs is sometimes called “neutral cost recovery” because it gives a deduction of the same present value as immediate expensing regardless of the timing.
Old Versus New Structures
Another issue relating to expensing for structures involves the treatment of structures bought before the tax change. A building erected the year before the tax relief would be written-off over thirty-nine years (in most cases), while a new building could be expensed. The newer building would have a clear tax advantage over the old, generating a capital loss for the owners of the older building. To avoid this loss, the old building could be sold to new owners, who could take advantage of the new expensing provision. However, this would require some expensing and wasteful churning of property.
Several steps could be taken if it were deemed proper to ameliorate the disadvantage to old buildings, without the need to change owners. Most immediate would be to allow all remaining (undepreciated) tax bases on old buildings to be expensed, in effect a retro-active enactment. A more gradual approach would be to grant old buildings the same time value adjustment on their remaining bases that the bill gives to NOLs on new buildings. This form of neutral cost recovery could be given over the remaining current-law lives of the old buildings, or over some arbitrary longer period to reduce the near-term revenue loss to the Treasury. For example, a building with twenty years left in its life could get the time value adjustment on the remaining basis if its owner agreed to spread the remaining basis over a new twenty-five, or thirty, or thirty-nine-year life. There are many approaches to dealing with this issue.
Expensing of capital investment is the most pro-growth feature of the draft House Republican Better Way tax reform plan. A large part of the benefit of expensing, over seventy percent, is due to the inclusion of outlays for structures. Their inclusion in the expensing provision would add significantly to economic growth and job creation, and would return higher revenue to the Treasury in the out-years. The draft bill deals successfully with the question of net operating loss carry-forwards where the write-off may be temporarily greater than current business revenue. It is silent on the treatment of old buildings which would have to compete with new, more tax-favored structures during the transition to the new tax structure. If the Congress wishes to address this transition issue, there are a variety of ways to ameliorate the divergence in tax treatment between old and new structures.
 This assumes the turned-over property is eligible for the expensing. The tax plan developed by Representative Devin Nunes (R-CA) seeks to prevent old buildings from benefitting from expensing by immediately reducing the remaining tax basis of old buildings to zero in the event of a sale, such that a sale would trigger a large taxable capital gain. The old residual basis could be depreciated later. This up-front tax on the sale would discourage the sale and limit the revenue loss to the Treasury, but would solidify the unequal tax treatments of new and old properties.