It took the COVID-19 virus or, specifically, the Coronavirus Aid, Relief, and Economic Security (CARES) Act, for taxpayers to finally get the technical corrections bill relating to Qualified Improvement Property through Congress. The CARES Act was signed into law by President Trump last week.
Previously under the Tax Cuts and Jobs Act of 2017 (TCJA), Congress enacted 100% bonus depreciation on qualifying property. Qualifying property is assets with a class-life of 20 years or less. The TCJA also combined three categories of qualified improvement property (qualified leasehold improvement property, qualified restaurant property and qualified retail improvement property) into one asset class called Qualified Improvement Property. The specific recovery period for this asset class was omitted from the statutory law. As a result, Qualified Improvement Property, which was intended to be treated as 15-year property, instead fell into the regular 39-year property for commercial real estate. In addition, the 100% bonus depreciation was disallowed as the property was no longer eligible for bonus depreciation and required businesses to capitalize the improvements, depreciating the improvement costs over 39-years as non-residential real property.
The CARES Act provides a technical correction specifically designating QIP property as 15-year asset class life, and thus eligible for bonus depreciation. The technical correction is retroactive and takes effect for qualifying property acquired and placed into service beginning January 1, 2018. This could have a significant impact to your real estate deductions, on a retroactive basis.
Taxpayers will now have the opportunity to correct their depreciation for QIP. Typically, correction for depreciation class lives and methods is done to “catch up” and allow for a permissible method change through a Form 3115 filing. It does not require amending tax returns. However, taxpayers can elect to amend 2018 returns to reflect the QIP and 100% bonus depreciation under the one-year depreciable property rule. We expect the IRS to issue further guidance on how to implement any changes necessary to retroactively and accurately reflect the proper depreciation that should have been taken.
Real estate owners should consult with their tax advisor for the best course of action to accelerate their depreciation for the 2018 and 2019 tax years. There are other tax related issues and changes under the CARES Act to take into consideration. These include, but are not limited to:
- Modification of interest limitation rules under Section 163(j),
- Changes to excess business losses and net operating losses rules,
- State tax adjustments, and
- Impacts to investor Schedule K-1’s.
Frequently Asked Questions
Q: What is qualified improvement property?
A: Qualified improvement property is defined as any improvement made by the taxpayer to an interior portion of a building, which is nonresidential real property, if such improvement is placed in service after the date such building was first placed in service by any taxpayer. QIP specifically excludes certain expenditures for the enlargement of a building, any elevator or escalator, and the internal structural framework of a building.
QIP is also qualified leasehold improvement property, retail improvement property, and restaurant property. These are separately identified categories of non-residential real property that are treated as 15-year qualified improvement property for tax purposes.
Taxpayers will need to segregate between interior vs. exterior improvements, as well as identify items specifically excluded from QIP.
Q: What is the effective date?
A: This is a retroactive provision. The effective date is for assets placed in service on or after January 1, 2018.
Q: How do I make this correction if I’ve already filed my 2019 tax return?
A: We are still awaiting guidance from the IRS on how to best correct previously filed tax returns, but we anticipate a change in accounting method will need to be filed through a Form 3115 or an amended tax return. If you are making a change prior to guidance, we recommend filing a method 7 change via a Form 3115 filing.
Certain partnerships are restricted from amending returns under the centralized partnership audit regime (CPAR) rules.
Q: Does my state conform?
A: Although QIP is eligible for 100% bonus depreciation for Federal purposes, many states do not conform to bonus depreciation and require a 39-year depreciable period.
Q: What About Interest Limitation (163(j))?
A: Taxpayers who have elected out of the interest limitations under 163(j) are required to use a 20-year ADS life for QIP. Real property, including QIP, is depreciated under ADS and is not eligible for bonus depreciation. However, any assets that can be segregated into personal property categories do not get the ADS treatment and, therefore, are still eligible for bonus depreciation.
Q: Could these expenditures be repairs?
A: Yes, you still should look at all expenditures under the tangible property regulations and apply the R.A.B.I. (restoration, adaptation, betterment and improvement) rules to determine whether the expenditure should be capitalized or expensed as a repair under the regulations.
To review other provisions from the CARES Act, click here.