Recent Changes to Depreciation of Qualified Improvement Property
On December 22, 2017, President Trump signed into law the Tax Cuts and Jobs Act (TCJA). While the TCJA was one of the largest overhauls in recent tax law history, it would require several additional publications for areas of guidance from both the Treasury Department and Internal Revenue Service, as well as several key technical corrections. One of the largest areas of technical corrections required would be the depreciable life of qualified improvement property.
Prior Tax Law
Under the 2017 TCJA, the separate definitions of Leasehold Improvement Property were eliminated. For tax years beginning after December 31, 2017, a 39-year recovery period was introduced for all “Qualified Improvement Property,” in the absence of corrective legislation. Qualified Improvement Property (QIP) is defined as any improvement made by a taxpayer to an interior portion of an existing building that is nonresidential real property. Examples of these improvements include installation or replacement of drywall, ceilings, interior doors, fire protection, mechanical, electrical and plumbing. It is important to note that QIP does not include any expenditures attributable to the enlargement of a building, an elevator/escalator or the internal structural framework of a building.
The significance of the change in terminology, is that it expanded the property definition, since it included property without regard to the line of business it is used for. With the TCJA stating for QIP property to use a 39-year tax life, such property became ineligible for the special depreciation allowance, known as bonus depreciation, under Internal Revenue Code Section 168(k). However, the expanded definition enabled certain improvements, such as roofs, heating, ventilation and air-conditioning property, fire protection and alarm and security systems made to non-residential property, to qualify for expensing under Internal Revenue Code Section 179.
On March 27, 2020, Congress passed the Coronavirus Aid, Relief and Economic Security (CARES) Act, P.L. 116-136, retroactively changing the recovery period for QIP to 15 years. Thus, making all QIP placed in service after December 31, 2017, eligible for bonus depreciation for tax years ended through December 31, 2026. On April 17, 2020, Rev. Proc. 2020-25 was released to provide additional guidance allowing taxpayers to change the depreciation of QIP placed in service by the taxpayer in a tax year ending in 2018, 2019 or 2020. The guidance indicates that a taxpayer may file an amended return for the year the QIP was placed in service and any affected succeeding tax years or complete a Form 3115, Application for Change in Accounting Method, with their current period tax return, to apply the retroactive changes made by the CARES Act.
Effectively, QIP property is eligible for bonus depreciation for tax periods ended through December 31, 2026. The applicable bonus depreciation percentage is 100% for property placed in service after September 27, 2017 through December 31, 2022, and phases down to 80% in 2023, 60% in 2024, 40% in 2025 and 20% in 2026. Additionally, QIP is eligible for the Section 179 expense deduction, up to $1,020,000 of qualifying property placed in service for tax periods ending December 31, 2019. The $1,020,000 expense limit is reduced dollar for dollar, but not below zero, to the extent that the taxpayer’s current year fixed asset acquisitions of qualifying property exceed $2,550,000. The overall Section 179 expense and limitation is increased for inflation annually, thus, making the overall expense limit $1,040,000 and corresponding acquisition limit to $2,590,000 in 2020.
Overall, the CARES Act brought forth the long-awaited technical correction regarding the depreciable life of qualified improvement property. The CARES Act corrected the errors created by the TCJA and restored the depreciable life of qualified improvement property to 15 years, making the property eligible for 100% expensing under Section 179 or bonus depreciation (for tax years ended through 2022), as originally intended by the TCJA.
Contributing authors: Nicholas L. Shires, CPA is the partner-in-charge of tax services at Dannible & McKee, LLP. Nick has over 19 years of experience providing tax and consulting services to a wide range of clients, including individuals and privately held companies. This article was also co-authored by Kaitlyn L. Mariano, CPA, a tax senior at Dannible & McKee, LLP. For more information on this topic, you may contact Nick at firstname.lastname@example.org or (315) 472-9127.