Questions and Confusion over Qualified Improvement Property
Typically when we have a major tax law change we have time to digest and discuss issues associated with the change. With the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) moving at such a rapid pace we have not fully digested some of the tax provisions. The importance of the Paycheck Protection Program and the Economic Injury Disaster Loans have rightfully sifted focus away from the Tax Provisions in the Law. This is abundantly clear with some of the miscommunication and confusion we are seeing in as it relates to Qualified Improvement Property (QIP). Due to the importance of this provision we wanted to take a few minutes to clear up some of the confusion and answer questions we are seeing from our clients.
To understand the confusion it begins with an understanding of the history behind QIP. For years the bonus depreciation regulations included “Qualified Real Property”. This included Qualified Improvement Property, a 39-year asset, Qualified Leasehold Improvement Property, a 15-year Asset, and Qualified Retail Property, a 15-year asset. Under the Tax Cuts and Jobs Act this was all replaced with QIP. However, a drafting error in the law made this all a 39-year asset not eligible for Bonus Depreciation, this drafting error was fixed under the CARES Act. Under the updated rules QIP is a 15-year asset, 20-year ADS, eligible for bonus depreciation.
The first question we will answer is: What is QIP? QIP consists of non-structural improvements, to the interior of a non-residential building, placed in service by the taxpayer, after the building is originally placed in service. In other words this can include drywall, interior lights, interior electrical, and plumbing systems. While QIP can be a windfall for people renovating their properties, as it allows them to write off large amounts of their capital expenditures, itis important to note that not everything qualifies. Companies are still required to separate exterior work, exterior HVAC systems, and structural items. Structural items include: load bearing walls, stairways, escalators, and other structural systems in the building. In order to maximize the deduction a cost segregation, or similar study, should be done to separate out these items. Additionally, the cost segregation study can separate out the personal property which could be beneficial for states that do not comply with bonus depreciation.
The next question relates to the three year rule. Under the old Qualified Leasehold Improvement test a property had to be in service for three years before the improvements were made in order to qualify. The new rules do not include this three year window, instead they simply require that the asset be placed in service after the building is placed in service. One thing worth noting about this change is that the original placed in service date of the building does not have to be by the current owner. While the improvements need to be made by the current owner in order to qualify, they can install them in an existing building that they just acquired. For example, a taxpayer can purchase an existing building and immediately start a renovation. The portions of the renovation that meet the requirements will qualify for the expanded bonus depreciation rules. This will allow many taxpayers to consider renovating existing buildings instead of building brand new properties.
The final confusing topic many taxpayers are facing relates to the “Real Property Trade or Business Election”. Many companies made this election to get around the interest limitations under 163(j)and maximize their business interest expense. Unfortunately, this irrevocable election requires companies depreciate their QIP using the Alternative Depreciation System (ADS). ADS by definition is not bonus eligible, and requires a 20-year life for QIP. As of the time I am writing this, the IRS has not announced any ways to revoke this election. However, due to the timing of the change the IRS may issue guidance in the coming weeks.
The late adoption of QIP has raised many questions including: How do you take additional deductions? how does the deduction work? as well as other questions. Typically CPAs and taxpayers would spend more time diving into each of these questions, but with the urgency surrounding the Paycheck Protection Stimulus and other portions of the CARES Act, companies have not been able to spend as much time on this provision. While this article covered some area of confusion, it did not cover all of the potential misinformation that exists. Please feel free to reach out to your McGuire Sponsel representative if you have any questions about this, or any other part of the CARES Act.