IRS issues guidance on bonus depreciation for qualified improvement property

On April 17, 2020, the IRS issued guidance on correcting depreciation for qualified improvement property (QIP), including catching up bonus depreciation from prior years. This guidance also provides rules for making late elections, or revoking elections, including the election out of bonus depreciation and the election to use the alternative depreciation system (ADS). Combined with previous guidance on withdrawing the real property trade or business election and amending partnership returns, taxpayers now have a much clearer picture of how to implement these changes.

Background

The retail glitch

Due to a drafting error in the Tax Cuts and Jobs Act (TCJA), QIP placed in service after Dec. 31, 2017, was not eligible for bonus depreciation — this was known as the “retail glitch.” Congress intended for QIP to be bonus-eligible; however, the TCJA did not specifically include a 15-year recovery period for QIP. Therefore, after the tax reform dust settled, QIP was nonresidential real property with a recovery period of 39 years, not eligible for bonus.

CARES Act technical correction

All of this changed with the passage of the Coronavirus Aid, Relief, and Economic Security (CARES) Act, which amended the Internal Revenue Code (IRC) to define QIP as 15-year property. The Act also updated the ADS recovery period for QIP to 20 years. Finally, the Act updated the definition of QIP to include any improvement “made by the taxpayer” (see discussion below). These changes are retroactive to 2018, i.e., to the passage of the TCJA.

QIP definition

“Qualified improvement property” means 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. QIP does not include expenditures attributable to (i) enlargement of the building, (ii) any elevator or escalator or (iii) the internal structural framework of the building.

The CARES Act added the phrase “made by the taxpayer” to the definition of QIP. Presumably, rules similar to the existing uniform capitalization (UNICAP) regulations, which address property produced by or for the taxpayer, will apply to determine if QIP is “made by the taxpayer.” The inclusion of this language may mean that partnership basis adjustments arising when a partner sells their interest may not qualify for bonus depreciation for the portion of the purchase price allocable to QIP — unfortunately, the recent guidance does not address this question. This phrase also likely rules out bonus depreciation on used QIP.