Bonus Depreciation Finally Available for Qualified Improvement Property Placed in Service After 2017
April 20, 2020
By Bahar A. Schippel and William A. Kastin
If you’re reading this Legal Alert, then you may be one of the many business owners, real estate professionals, restauranteurs, or retailers who were disappointed at how the tax law changes enacted in the Tax Cuts and Jobs Act of 2017 (“TCJA”) prohibited you from taking bonus depreciation for various types of interior improvements, referred to as qualified improvement property (“QIP”), to your non-residential real property. It took more than two years and a global pandemic, but Congress has finally changed the law that prevented you from taking bonus depreciation on QIP. As discussed below, as a result of changes enacted as part of the Coronavirus Aid, Relief, and Economic Security Act (‘‘CARES Act”), not only have such improvements become currently eligible for bonus depreciation, but there is a process for obtaining such benefits for QIP acquired and placed in service by a taxpayer after December 31, 2017.1
In general, improvements to non-residential real property have a 39-year depreciation recovery period. Prior to the TCJA, an additional first year bonus depreciation rule had three components which, when working together, could significantly benefit taxpayers.
First, the rules established, among others, three categories of non-residential real property interior building improvements – (i) qualified leasehold improvement property, (ii) qualified restaurant property, and (iii) qualified retail improvement property.
Second, the rules provided that property falling within any of those three categories would be treated as having a 15-year depreciation recovery period.
Third, and likely most significantly, the rules provided that property with a depreciation recovery period of 20 years or less would be eligible for additional first year bonus depreciation.
As a result, interior building improvements previously subject to a 39-year depreciation recovery period were eligible for first year bonus depreciation. The law has been modified over time, and prior to the TCJA, examples of improvements which qualified for bonus depreciation included lighting fixtures, flooring, and certain other internal building improvements.
In 2017, the TCJA revised the bonus depreciation rules to replace the above three categories of improvements with a single, more comprehensive, category referred to as “Qualified Improvement Property” or QIP. However, in making that revision, the TCJA did not provide that QIP would have a 15-year depreciation recovery period, and as a result, QIP would be treated as having a 39-year depreciation recovery period pursuant to the general rule. Significantly, because bonus depreciation is only available for property with a depreciation recovery period of 20 years or less, QIP was not eligible for bonus depreciation. And so, the TCJA put many taxpayers in a worse position than they were in previously – eliminating bonus depreciation for interior building improvements that previously qualified for such treatment under one of the three categories mentioned above.
II. The CARES Act and Subsequent IRS Guidance
The CARES Act permanently and retroactively (i.e., effective for property placed in service after 2017) treats QIP as (i) 15-year property under the modified accelerated cost recovery system, (ii) 20-year property under the alternative depreciation system, and (iii) eligible for bonus depreciation.2
If the CARES Act is described as the broad stroke setting forth Congressional intent, then a combination of recently released IRS Revenue Procedures may best be described as the fine details that help taxpayers accomplish the desired goal. Although the CARES Act did not address how to overcome the technical hurdles required to get the desired retroactive relief, a combination of Revenue Procedures now address the mechanics of revoking or withdrawing various elections which might, depending on the circumstances, be required to ensure that businesses can benefit from bonus depreciation for QIP acquired and placed in service after December 31, 2017.
As we discussed previously in a legal alert 3, prior to the CARES Act, subject to certain exceptions, a taxpayer’s business interest deductions were generally limited to 30% of the taxpayer’s adjusted taxable income (“30% Limitation”).4 One of those exceptions provided that certain real property businesses could make an irrevocable election to be excluded from the 30% Limitation, enabling them to deduct 100% of their business interest deductions (as opposed to deducting business interest deductions equal to only 30% of their adjusted taxable income).
However, there was a trade-off – if a taxpayer made the election so that it was not limited by the 30% Limitation, then such taxpayer would not be eligible for bonus depreciation. In other words, prior to the CARES Act, many real-estate oriented taxpayers would compare (i) the benefits of deducting 100% of their business interest deductions to (ii) the benefits of bonus depreciation. Prior to the CARES Act, this comparison was fairly easy because bonus depreciation wasn’t available for QIP. Thus, many qualifying real estate businesses made the election to be excluded from the 30% Limitation. However, now that bonus depreciation is retroactively available for QIP placed in service in 2018 and 2019, electing businesses that acquired and placed QIP in service during such years may want to consider whether to revoke that election by comparing the tax benefits of being exempt from the 30% Limitation to the tax benefits of bonus depreciation for their QIP.
Assuming a taxpayer prefers the benefit of bonus depreciation for its QIP, there are still technical hurdles to overcome to accomplish that goal. Three recently published Revenue Procedures explain how to overcome those technical hurdles – explaining how to both (i) retroactively revoke or withdraw previously made irrevocable elections, and (ii) make new retroactive elections – so that, after making all of the necessary changes, the technical aspects associated with filing tax returns sync up with the overarching intent of the CARES Act. Under the Revenue Procedures, there are different procedures, applicable to individuals, corporations, partnerships, and even among different partnerships. As a high-level summary:
- Rev. Proc. 2020-23 explains how certain eligible partnerships under the Bipartisan Budget Act of 2015 can file amended partnership tax returns to take advantage of CARES Act relief;
- Rev. Proc. 2020-25 explains (i) how partnerships not covered by the guidance set forth in Rev. Proc. 2020-23 can file Administrative Adjustment Requests under Code § 6227 (as opposed to amended partnership tax returns)5, and (ii) how all applicable taxpayers could change their method of accounting respecting bonus depreciation of their QIP under Code § 168); and
- Rev. Proc. 2020-22 explains how a taxpayer can retroactively withdraw, revoke, and/or make certain elections under Code § 163(j), the implications of which impact such taxpayer’s ability to take advantage of bonus depreciation under Code § 168.
The guidance is detailed and complex and may be supplemented in the future. For the time being, taxpayers and their advisors can make themselves aware of these rules, and can take some comfort in knowing that the IRS is providing guidance to accomplish the goals set forth in the CARES Act.
Guidance in response to the COVID-19 pandemic is constantly being updated. This Legal Alert is merely intended to introduce you to the applicable rules and is not a substitute for careful tax planning. If you have any questions, you are strongly encouraged to reach out to your tax advisor.
For other tax relief measures:
- In certain instances, QIP acquired as far back as September 28, 2017, and placed in service after December 31, 2017 may qualify for bonus depreciation under the TCJA, and if acquired prior to September 28, 2017, bonus depreciation may have been available under prior law.
- See, Code § 168(e)(3)(E)(vii), providing that qualified improvement property is classified as 15-year property.
- “The Cares Act Includes Many Tax Incentives for Businesses – Expands Ability to Take Losses and Deductions”, March 30, 2020, by Bahar Schippel and Bill Kastin. https://www.swlaw.com/publications/legal-alerts/2714
- Code § 163(j).
- Requiring, for example, that an AAR may be filed by a partnership so long as the AAR and all other affected returns reflect (i) the adjustments to taxable income from the change in depreciation of QIP and (ii) all collateral adjustments to taxable income or to tax liability. For example, if a partnership’s AAR is made for 2018, then any original or amended tax return or AAR for any succeeding year must reflect all applicable adjustments.
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