Bonus Depreciation Creates an Opportunity, but Requires an Overall Tax Analysis
The 2017 Tax Cuts and Jobs Act (“TCJA”) amended IRC section 168(k) to eliminate qualified improvement property (“QIP”) as a specific category of qualified property eligible for additional first-year depreciation known as “bonus depreciation”. In addition, the 2017 TCJA eliminated the 15-year categories for qualified leasehold improvement property, qualified retail improvement property, and qualified restaurant property. These provisions are effective for taxable years beginning after 2017.
QIP was defined as any improvement 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. Such property does not include expenditures attributable to the enlargement of a building, any elevator or escalator, or the internal structural framework of a building. The term “internal structural framework” generally includes all load-bearing internal walls and any other internal structural supports essential to the stability of the building.
The 2017 TCJA also increased bonus depreciation from 50% to 100% and changed the phase-out period from the two-year period beginning with the 2018 taxable year (two-year period beginning with the 2019 taxable year for longer production period property) to the four-year period beginning with the 2023 tax year (four-year period beginning with the 2024 tax year for longer production period property). These provisions are effective for eligible property acquired and placed in service after September 27, 2017.
Property eligible for bonus depreciation has a recovery period of 20-years or less. Although the text of the 2017 TCJA stated that QIP is assigned a 15-year recovery period and a 20-year class life, the IRC failed to include these amendments. As a result, QIP continued to be recovered over a 39-year period and was ineligible for bonus depreciation when placed in service after 2017.
The 2020 CARES Act assigns a 15-year recovery period and a 20-year class life to QIP. In addition, the words “made by the taxpayer” are inserted after “any improvement” in the definition of QIP which disqualifies any improvements not made by the taxpayer.
These technical amendments are effective for QIP placed in service after December 31, 2017.
Overall Tax Analysis
Taxpayers who placed QIP in service after 2017 should begin planning for the additional federal tax depreciation that will result from this technical amendment and consider the following:
- Review fixed asset records to identify capitalized improvements to non-residential real property made by the taxpayer during 2018 and 2019 after the date the building was first placed in service even if the building was placed in service in such year. The cost of such amounts should be segregated to exclude the cost of any exterior improvements such as doors, windows, rooftop HVAC units, land improvements, etc., building additions that increase the overall volume of the building, any load-bearing interior structures that stabilize the building, and mechanical components of elevators and escalators.
- Quantify the amount of additional federal tax depreciation resulting from a change from a 39-year recovery period to a 15-year recovery period and any change from not claiming bonus depreciation to claiming 100% bonus depreciation on such property.
- The impact the additional federal tax depreciation and bonus depreciation has on federal taxable income or loss for the 2018 and 2019 tax years. This impact could result in federal tax refunds for prior tax years and a reduction of 2020 federal estimated tax payments.
- The timing of IRS procedures for changing the MACRS recovery period for QIP for filed 2018 and 2019 tax returns.
- The timing of IRS procedures to make or revoke a bonus depreciation election for 15-year property for filed 2018 and 2019 tax returns.
- The timing of IRS procedures to revoke an election for 2018 and 2019 filed returns to not limit business interest expense whereby QIP is recovered using ADS and is not eligible for bonus depreciation. The revocation of this election impacts the amount of business interest that may be deducted.
- The timing of state decisions whether to conform or decouple from each provision of the CARES Act.
The federal income tax savings resulting from the QIP technical amendment will likely result in a significant federal tax savings for taxpayers that placed QIP in service after 2017. However, this technical amendment interacts with other provisions of the CARES Act and advance planning should be undertaken to fully understand such interaction before changing prior year tax returns.
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