Bonus depreciation & qualified improvement property
The Tax Cuts and Jobs Act of 2017 (TCJA) made some significant changes to depreciation rules, but the final wording of the new law excluded some businesses from benefits that many thought Congress had intended they receive. The TCJA expanded bonus depreciation rules to allow a 100% writeoff for certain property acquired after Sept. 27, 2017, and placed in service before Jan. 1, 2023. However, another provision of the new law reclassified many improvements to nonresidential buildings to make them ineligible for this treatment.
Prior to the TCJA, many interior improvements to nonresidential buildings were eligible for bonus depreciation as qualified improvement property (QIP). The new law specifically excluded this category of asset from bonus depreciation eligibility. Furthermore, the new law also eliminated separate asset categories for qualified leasehold improvements, qualified restaurant property, and qualified retail improvement property, effectively lumping all these separate classes into the QIP category that no longer qualifies for bonus depreciation.
As a result of the repeal of separate classifications for retail and restaurant property and the removal of QIP from bonus depreciation eligibility, many taxpayers were seemingly shut out from being able to claim 100% bonus depreciation. This is commonly referred to as “the retail glitch.”
IRS and Treasury have explicitly stated in final regulations on TCJA bonus depreciation that they lack the authority to change this glitch through administrative means.
Compounding the confusion, in the months leading up to the enactment of the new law, the IRS had released guidance about pre-TCJA bonus depreciation that seemed to indicate that QIP would be eligible for bonus treatment as 15-year (or at worst, 39-year) depreciable property. Information has come out after the enactment of the TCJA, indicating that Congress did intend to change the depreciable life of QIP to 15 years — making it bonus eligible under the new law.
Nevertheless, IRS and Treasury have explicitly stated in final regulations on TCJA bonus depreciation that they lack the authority to change this glitch through administrative means. It must be corrected legislatively. There have been murmurs in Congress that a fix is on its way, and that it has bipartisan support, but it remains to be seen if and when this legislation will come to a vote.
Origin of the QIP asset class
The QIP asset class first came into the tax code as part of a 2015 law that created it for property placed in service on or after Jan. 1, 2016. It was defined as, “any improvement 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.” Certain types of improvements were specifically excluded from QIP, such as: the enlargement of the building, any elevator or escalator, or the changes to internal structural framework of the building. QIP improved on the asset classification that came before it in two ways. First, the property didn’t have to be subject to a lease between unrelated parties to be eligible. Second, there was only a one-day waiting period for property to be considered QIP, as opposed to a three-year waiting period under the previous rules. On the downside, QIP had a 39-year depreciable life as compared to the 15-year life of asset class it replaced.
In 2017, the IRS issued Rev. Proc 2017-33, which clarified that the term, “first placed in service” meant the first time the building was placed in service by any person, whether in a trade or business, in the production of income, in a tax-exempt activity or personal activity.
This procedure also clarified that both qualified restaurant property (QRP) and qualified retail improvement property (QRIP), both of which have a 15-year depreciable life and were not considered bonus eligible, could be treated as QIP. It went on to state that QIP would be eligible for first-year bonus depreciation provided that all of the other criteria under pre-TCJA rules were met. Moreover, these subclasses of QIP would still retain their 15-year depreciable life.
Pros, cons, and next steps for Sec. 179
There is a small sliver of hope for some. The TCJA did expand the availability of first-year expensing of assets under Sec. 179 to include QIP. There are downsides to Sec. 179 treatment, though. First, there is a limitation on how much property can be expensed under this method. The deduction phases out dollar-for-dollar for new asset additions in excess of a statutory threshold ($2 million in 2019), disappearing altogether once a business’ total asset additions for the year exceed the threshold by an amount that phases the deduction down to zero. Second, a Sec. 179 deduction cannot generate or increase a tax net operating loss, so it can only be used to the extent the business has taxable income in the year the assets are added. On top of the limitations, certain activities, such as rentals, may not be eligible for this treatment.
The TCJA did expand the availability of first-year expensing of assets under Sec. 179 to include QIP.
For those taxpayers who have QIP that would otherwise qualify for bonus depreciation and who are limited from taking 179 expensing, there are a few options. The first option is to track property and designate it as QIP in fixed asset listings. In the event of a technical correction, it’ll be likely that an automatic consent change in accounting method will be made available to allow you to go back and claim the additional depreciation deductions via a 481(a) adjustment or amended return. Second, depending on the type and amount of expenditures, it may be worth having a cost segregation study performed to determine if a portion of the property qualifies as a different class of asset with a shorter depreciable life that might be considered bonus eligible.
If you have any questions about the classification of assets as QIP and eligibility for bonus depreciation, please contact your Plante Moran engagement team.