Bonus depreciation on qualified improvement property

[Updated April 9, 2020, for issuance of Rev. Proc. 2020-23]

We have good news and we have bad news.

The good news is that as part of the Coronavirus Aid, Relief, and Economic Security (CARES) Act, Congress fixed the so-called “retail glitch,” and made qualified improvement property (QIP) eligible for bonus depreciation retroactive to 2018. This is a big relief for taxpayers, especially those in the retail and restaurant industries, which have been forced to close or severely cut back operations because of the coronavirus outbreak. This provision may allow many taxpayers to obtain tax refunds related to expenditures for renovation projects completed in the last few years.

The bad news is that since the relief is retroactive to 2018, the provision has the potential to unleash a storm of administrative complexity in the form of amended returns, superseding returns, and accounting method changes (Form 3115). In other words, actually claiming bonus depreciation two years after the Tax Cuts and Jobs Act (TCJA) may be easier said than done in many situations. And perhaps the worst news is that taxpayers in real property trades or businesses who elected out of the business interest deduction limitation cannot take bonus depreciation on QIP. Unfortunately, election is irrevocable, so unless Congress changes the statute, those taxpayers are stuck with a long recovery period for QIP.

Background

The retail glitch

Due to a drafting error in the 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 CARES Act, which amended the Internal Revenue Code (IRC) to define QIP as 15-year property. The Act also updated the alternative depreciation system (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 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.