The recently enacted Coronavirus Aid, Relief and Economic Security (CARES) Act fixes the “retail glitch” and once again makes qualified improvement property eligible for bonus depreciation. Prior law required QIP placed in service after December 31, 2017 to use a 39-year tax life and the property was not eligible for bonus depreciation. The CARES Act retroactively changed this recovery period to a 15-year tax life, which makes QIP bonus depreciation eligible through 2026.
Background on the “retail glitch”
The legislative fix in the CARES Act addresses an inadvertent issue that arose when the Tax Cuts and Jobs Act was enacted in 2017. The TCJA consolidated three categories, qualified leasehold improvement property, qualified retail improvement property and qualified restaurant property into a new category of assets called QIP.
When it enacted the TCJA, Congress intended to make QIP eligible for 100% bonus depreciation, however, due to a drafting error, the statute failed to assign the 15-year recovery period to QIP. As a result, QIP defaulted to a 39-year recovery period for the General Depreciation System and a 40-year recovery period for the Alternative Depreciation System.
Tax implications and opportunity with the CARES Act
In order to be classified as QIP, a taxpayer must make improvements to an interior portion of an existing building that is nonresidential real property — residential rental property is excluded. Examples of such qualifying improvements include installation or replacement of drywall, interior doors, ceilings, mechanical, fire protection, electrical and plumbing. QIP does not include improvements attributable to internal structural framework, enlargements to the building or elevators or escalators.
While this favorable change in the tax law has wide applicability to many taxpayers, businesses in retail, restaurant and hospitality stand to benefit the most, as they frequently renovate their locations. It would be especially beneficial for these types of companies to revisit their capital improvements in the last couple of years and evaluate the applicability of the new tax law change to claim additional tax depreciation.
With the CARES Act, QIP placed in service after December 31, 2017 generally qualifies for a 100% bonus deduction. However, QIP considered acquired before September 28, 2017 (e.g., because construction began before that date) does not qualify for the 100% rate, even if it was placed in service after 2017. Instead, QIP acquired before September 28, 2017 qualifies for a 40% bonus rate if it was placed in service in 2018, or a 30% bonus rate if it was placed in service in 2019.
In order to claim the additional prior-year QIP bonus depreciation, taxpayers can file amended tax returns or file an Application for Change in Accounting Method (Form 3115), both of which are highlighted in the example below.
· Company X, a calendar-year taxpayer, places assets into service in 2018 with a cost basis of $500,000 and claims a $12,821 ($500,000/39 years) tax depreciation deduction. A straight-line deprecation calculation is used in this example for simplicity purposes.
· Company X has not filed its 2019 tax return.
· Company X may amend its 2018 tax return and recompute its 2018 taxable income by claiming a $500,000 bonus depreciation deduction.
· Alternatively, Company X may file a Form 3115 with its 2019 tax return and claim a $487,179 deduction ($500,000 bonus depreciation for 2019 less the $12,821 deduction claimed for 2018). Company X reports this amount as a negative IRC Section 481 adjustment, thus reducing its 2019 taxable income.
As a result of the legislative fix made via the CARES Act, taxpayers may now claim bonus depreciation for QIP retroactively to when the TCJA was enacted into law. Taxpayers who have claimed depreciation deductions for QIP on post-TCJA tax returns using a 39-year life and no bonus depreciation may still be able to benefit from the change.
For more information on tax issues in Florida, contact Mathew Abraham at email@example.com or 813-384-2741.
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