One provision of the Coronavirus Aid, Relief and Economic Security (CARES) Act that could provide immediate cash benefits is the technical correction that makes qualified improvement property (QIP), placed in service after 2017, 15-year property and eligible for 100% bonus depreciation.
Internal Revenue Code section 168(e)(6) defines QIP as any improvement made by the taxpayer to an interior portion of a building which is nonresidential real property (residential rental property is excluded) if such improvement is placed in service after the date such building was first placed in service.
Examples of such qualifying improvements include installation or replacement of interior doors, drywall, flooring, ceilings, fire protection, plumbing and electrical. Items that are specifically excluded consist of expenditures which are attributable to
1) the enlargement of the building;
2) any elevator or escalator; or
3) the internal structural framework of the building.
The Tax Cuts and Jobs Act of 2017 (TCJA) originally intended for QIP to be 15-year property and bonus depreciation eligible. However, due to an oversight when TCJA was enacted, QIP was not included in the definition of 15-year property. As a result, QIP was 39-year property and not eligible for bonus depreciation. The IRS had no authority to correct the oversight without a legislative fix.
A little over two years later, the legislative fix arrived with the passing of the CARES Act. The fix has been made retroactively to January 1, 2018. QIP placed in service after 2017 is now 15-year property and qualifies for bonus depreciation.
Bonus depreciation allows businesses to deduct 100% of the cost of eligible property in the year it is placed in service after September 27, 2017 and before January 1, 2023. After 2022, the amount of allowable bonus depreciation is phased down over four years.
How to take advantage and realize the benefit
All companies that have QIP can take advantage of this legislative correction. Taxpayers should review 2018 and 2019 improvements to existing nonresidential buildings to identify QIP. A cost segregation study may be helpful in identifying eligible costs. Once QIP has been identified, the method to claim the deduction can be determined.
The IRS issued Revenue Procedure 2020-25 that permits taxpayers to file an amended return or a Form 3115, Application for Change in Accounting Method to change their depreciation of qualified improvement property placed in service after December 31, 2017.
- Taxpayers who have QIP in 2019 and have not filed their 2019 federal income tax returns yet can treat QIP assets as 15-year property and eligible for 100% bonus depreciation in their 2019 federal return.
- Taxpayers who have filed their 2019 federal income tax returns treating QIP in 2019 as 39-year property and are therefore not eligible for 100% bonus depreciation may file a superseding 2019 return prior to the due date (including extensions) and change QIP to 15-year property and claim bonus depreciation. However, if the due date for the tax return has passed, then the taxpayer may amend the 2019 return to claim QIP as 15-year property and claim bonus depreciation.
- Taxpayers who have QIP in 2018 and who have filed their 2018 federal income tax returns treating QIP assets as 39-year property and are therefore not eligible for 100% bonus depreciation should consider amending those returns to treat QIP as 15-year property and bonus eligible
As an alternative to amending tax returns, taxpayers may file for an automatic Change in Accounting Method with Form 3115 on the 2019 or 2020 taxable year to claim the accelerated depreciation. As an example, Form 3115 could be filed with the 2019 tax return for QIP placed in service during 2018. By filing Form 3115 and changing the depreciation life of 2018 QIP property, the missed accelerated depreciation can be captured on the 2019 tax return.
The correction to the QIP glitch is a great opportunity for many taxpayers. However, due to the correlation between depreciation and other provisions, uniform capitalization rules under Section 263A, interest expense limitation under Section 163(j), and the GILTI deductions under Section 250, taxpayers should carefully consider the impact of adjusting depreciation expense on all applicable provisions when evaluating the methods to take advantage of the QIP fix.
If you have questions about QIP and the developments mentioned above, contact your Warren Averett advisor or ask a member of our team to reach out to you.