The Tax Cuts and Jobs Act (TCJA) contained a drafting error that adversely affected real estate qualified improvement property (QIP). Congressional Republicans have been trying to fix the so-called “retail glitch” for more than two years.

A provision of the Coronavirus Aid, Relief, and Economic Security (CARES) Act retroactively changes the classification of QIP from 39-year property to 15-year property, thereby making it eligible for first-year bonus depreciation. The technical correction could lower your tax bill for building improvements in future tax years, as well as possibly providing opportunities to recover some federal income taxes paid in 2018 and 2019 — but you may need to amend prior returns to receive the benefits. Here’s the story.

100% Bonus Depreciation vs. 15-year Straight Line Depreciation

QIP refers to an improvement to an interior portion of a nonresidential building that’s placed in service after the date the building was first placed in service. However, improvements related to the enlargement of a building, any elevator or escalator, or the internal structural framework are specifically excluded from the definition of QIP for this purpose.

Due to a drafting error in the TCJA, any QIP placed in service after December 31, 2017, wasn’t eligible for 100% bonus depreciation. Instead, the cost of QIP had to be deducted straight-line over a 39-year period.

Fortunately, the CARES Act, signed into law on March 27, 2020, corrects the TCJA drafting error for QIP. Thus, most businesses now have the choice to either:

• Claim 100% bonus depreciation for QIP placed in service after December 31, 2017, or
• Depreciate the QIP placed in service after December 31, 2017, straight-line over 15 years.

Either option will result in lower taxable income over the short run than under the TCJA’s 39-year depreciation period.

Applying the Change to Prior Years

During the coronavirus (COVID-19) crisis, cash flow and borrowing capacity may be tight. So, most businesses aren’t currently positioned to undertake new capital expenditures — even if a building improvement is needed as a practical matter and the technical correction makes it more affordable.

But, because the correction is retroactive, it can reach back to apply to any QIP placed in service after December 31, 2017. This presents the following favorable opportunities for qualifying expenditures you’ve already made:

• For not-yet-filed 2019 returns, you can simply reflect the favorable treatment for QIP on the return.
• For already-filed returns for 2018 and 2019 that didn’t claim 100% bonus depreciation for QIP placed in service in those years, you can amend those filings to take advantage of 100% first-year bonus depreciation — or the shorter 15-year depreciation period.

Under recent IRS guidance, to change depreciation of QIP placed in service after December 31, 2017, you may file an amended return or a Form 3115, “Application for Change in Accounting Method.” Doing so should result in a lower federal income tax bill for the tax year the QIP was placed in service or the year the Form 3115 is filed to claim the additional depreciation deduction.

You may be eligible for a refund or a one-time downward adjustment to income on your current return. In some cases, particularly if you elect 100% first-year bonus depreciation for a substantial improvement, it may generate a net operating loss (NOL) that, for C corporations, may be carried back five years under another favorable CARES Act provision.

We Can Help

Contact us to discuss your options claiming deductions for QIP placed in service after December 31, 2017. Our tax professionals can help you identify QIP expenditures and file the appropriate forms to qualify for tax relief during these difficult times.

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