Qualified Improvement Property (QIP): A Technical Fix from the CARES Act

Updated 4/27/2020 at 3:06pm ET

The CARES act, signed into law on Friday, March 27, 2020, corrects a drafting error in favor of many real estate owners.

[sch_pullbox]SC&H’s Key Takeaways

• Qualified Improvement Property (QIP) is now eligible for 100% deductible bonus depreciation
• QIP includes improvements made by the taxpayer to the interior of a non-residential building which were placed into service after the building itself was first placed in service
• 100% bonus depreciation may be particularly useful to retailers, restaurants, and commercial real estate owners
• Taxpayers should be mindful of interactions between bonus depreciation, Section 179 deductions, and state decoupling rules
• Taxpayers should review filing strategies and compare costs / benefits of amending previously filed returns vs. “catching-up” depreciation in future years
• Cost Segregation Studies may be useful in identifying property applicable for bonus depreciation benefits[/sch_pullbox]

The Tax Cuts and Jobs Act (TCJA, AKA “Tax Reform”) passed at the end of 2017 made the most sweeping changes to the US income tax system since 1986. One of those changes was to consolidate a number of similar, and confusing, depreciation rules into a single clear section of the tax code.

Prior to TCJA, interior improvements to real property could fall into a number of categories such as qualified leasehold improvement property, qualified retail improvement property, or qualified restaurant property. Each of these types of property has similar, but different, definitions and deprecations rules. TCJA consolidated all these types of property with one definition: Qualified Improvement Property (QIP).

QIP is defined as any improvements to the interior of a non-residential building placed in service after the building itself is placed in service, but does not include the enlargement of a building, internal structures of a building or escalators / elevators.

TCJA also expanded the definition of bonus depreciation (so called immediate expensing rules) to allow many assets placed into service after December 31, 2017 to be immediately and fully depreciated. This provision was seen as a boon for restaurant, retail, and commercial real estate industries who could now expense their buildout costs (i.e. QIP mentioned above).

Alas, due to a drafting error, the newly defined QIP was not included in the list of assets eligible for 100% bonus depreciation.

Impact of CARES Act:

The CARES act makes technical amendment to TCJA to change the depreciable life of QIP from 39 years to 15 years for improvements made by the taxpayer, thus specifically making QIP eligible for 100% bonus depreciation. The change is retroactive for assets placed into service after December 31, 2017.

Practical Considerations:

• Taxpayers who placed QIP into service in 2019 and who have not filed their 2019 federal income tax returns yet can now treat QIP assets as 15 year property eligible for bonus depreciation.
  • This may result in significant overpayments for some taxpayers who had planned to only be able to take advantage of 39 year depreciation.
• Taxpayers who placed QIP into service in 2019 and who have already filed their 2019 federal income tax returns may have several options:
  • If the return was filed without an extension, then an amended 2019 tax return may be required to take advantage of 100% bonus depreciation.
    • In the case of pass-through entities such as partnerships or S-Corporations, individual tax returns of Owners / Partners / Shareholders may also need to be amended to obtain a refund of taxes paid.
    • The IRS has released special rules and eligibility requirements for amending tax returns of so-called “BBA partnerships” in Rev. Proc 2020-23.
  • If an extension was filed for the returns, or if the original due date for the return has not yet been reached, a superseded return may be filed reflecting the bonus depreciation on QIP assets.
• Taxpayers who placed QIP into service in 2018 may have several options:
  • 2018 tax returns can be amended reflecting the bonus depreciation on QIP assets.
    • This would change taxable income for tax year 2018 and possibly 2019 (if previously filed).
    • The IRS has released special rules and eligibility requirements for amending tax returns of so-called “BBA partnerships” in Rev. Proc 2020-23.
  • File Form 3115 “Application for Change in Accounting Method” requesting an automatic change in depreciation accounting to “catch up” depreciation from 2018 on the 2019 tax return.
  • Special rules for filing Form 3115 are outlined in Rev. Proc 2020-25.
• Taxpayers who placed QIP into service in 2018 or 2019 who have already filed the applicable tax returns could decide to simply file Form 3115 “Application for Change in Accounting Method” with their 2020 tax returns and catch up all past depreciation benefits in the 2020 tax year.
  • Special rules for filing Form 3115 are outlined in Rev. Proc 2020-25.

Planning Items for Consideration:

• Due to the interplay between other attributes of the tax code such as UNICAP rules under IRC Section 263A, Section 163(j) interest limitations, newly enacted GILTI provisions, Net Operating Loss (NOL) rules, and others, taxpayers should consult their tax advisor before making decisions on how best to proceed.
• Many states “decouple” from federal bonus depreciation rules (i.e. they do not recognize the immediate expensing), so tax benefits at the state level(s) may be limited.
• Some assets may have been deducted under IRC section 179 expensing rules in years past and the possible benefits of bonus depreciation treatment may be little or nothing.
• Cost Segregation Studies may be needed to appropriately identify the amount of assets that qualify as improvements made by the taxpayer to the interior of a non-residential building which were placed into service after the building itself was first placed in service.

Please contact the SC&H Tax Team for further advice or questions.