The Coronavirus Aid, Relief, and Economic Security Act (CARES Act) includes a welcomed technical correction that assigns a 15-year recovery period to qualified improvement property (QIP) placed in service after 2017. Without the technical correction a 39-year recovery period applied.
While the shortened 15-year recovery period is good news, its real significance is that most post-2017 QIP retroactively qualifies for the bonus depreciation deduction. Any MACRS property with a recovery period of 20 years or less is bonus depreciation property.
Bonus Depreciation of QIP
QIP placed in service after 2017 now 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 is placed in service after 2017. Instead, QIP acquired before September 28, 2017 qualifies for a 40% bonus rate if it is placed in service in 2018, or a 30% bonus rate if it is placed in service in 2019.
A 100% bonus rate applied to QIP acquired after September 27, 2017 and placed in service in 2017 regardless of the QIP depreciation period. A 50% rate applied to QIP acquired before September 28, 2017 and placed in service in 2017. The technical correction in the CARES Act has no impact on this property.
QIP Definition Clarified
QIP is an internal structural improvement (section 1250 property) made to nonresidential real property after the real property is placed in service.
However, QIP does not include expenditures attributable to:
- the enlargement of a building,
- an elevator or escalator, or
- the internal structural framework of a building.
The CARES Act clarifies that the improvement must be “made by the taxpayer.” This means that a taxpayer may not purchase real estate and treat improvements previously made by the seller as QIP. However, this requirement is not expected to affect lessors who gave construction allowances to tenants that allow them to depreciate improvements the tenants built.
Taking Action: Form 3115 and Amended Return Options
Taxpayers who filed returns that used a 39-year recovery period to depreciate post-2017 QIP file a Form 3115, Application for Change of Accounting Method, or an amended return in order to take advantage of the new 15-year recovery period.
However, the IRS has informally confirmed that it will issue additional guidance in the coming weeks. Many hope this guidance may provide a simpler method for taxpayers to correct their prior returns. Consequently, practitioners may wish to wait until specifics are released.
Automatic Accounting Method Changes
Under general tax accounting rules, taxpayers who filed more than one return that used the now incorrect 39-year recovery period to depreciate QIP have adopted an impermissible method of accounting. Taxpayers usually correct this type of error by:
- filing an automatic accounting method change on Form 3115, and
- claiming a negative (favorable) section 481 adjustment for the difference between the 100% bonus depreciation deduction and the depreciation that was actually claimed.
However, a taxpayer that filed only one incorrect return may either file an amended return or, if more convenient or advantageous, file Form 3115. For example, a taxpayer that placed QIP in service in 2018, and has not yet filed a 2019 return, may file Form 3115 with the 2019 return rather than filing an amended 2018 return even though an impermissible accounting method was not adopted.
Example: REAL Corp., a calendar year taxpayer, places QIP in service in 2018 with a cost basis of $100,000 and claims a $2,564 ($100,000/39 years) depreciation deduction. REAL has not filed a 2019 return. REAL may amend its 2018 return before it files its 2019 return and recompute its 2018 taxable income as if by claiming a $100,000 bonus deduction. Alternatively, REAL may file a Form 3115 with its 2019 return and claim a $97,436 deduction ($100,000 bonus depreciation for 2019 – $2,564 deduction claimed for 2018). REAL reports this $97,436 deduction as a section 481 adjustment in computing its 2019 taxable income.
In addition to filing Form 3115 with the return for the year of change, a taxpayer must file Form 3115 with the IRS’s Ogden Utah office. The Ogden office filing is due when the tax return with the Form 3115 is filed.
Bonus Depreciation Elections and QIP
Some taxpayers may prefer to use a 15-year recovery period, rather than 100% bonus depreciation on 15-year QIP that was depreciated over 39 years. Although bonus depreciation must be claimed on a qualifying property unless a timely election out is made, it is likely that the expected IRS guidance will allow taxpayers to make a late election out in order to use the 15-year recovery period.
However, taxpayers should be careful with this option. Since QIP is not a separate category of bonus depreciation property after 2017, any late election out should apply to all property within the 15-year class that was placed in service during the tax year. Thus, the election out may not be limited to just to 15-year QIP. Of course, the IRS guidance could provide otherwise.
Other Election-Out Considerations
If a late election out of bonus depreciation is allowed the 15-year recovery period applies and the taxpayer has still used an incorrect 39 year recovery period. Consequently, making an election out will not offer an escape from filing a Form 3115 or, alternatively, an amended return unless the IRS guidance provides otherwise.
On the flip side, the IRS guidance should also allow a taxpayer to revoke an election out of bonus depreciation that was made for the 15-year property class if 15-year QIP was also placed in service and depreciated over 39-years during the tax year of the election out. The taxpayer could then claim bonus depreciation on the QIP and any other 15-year property placed in service during the tax year, by filing Form 3115 or an amended return, or possibly some other method provided in the guidance.
The IRS may need to address one additional election. Taxpayers could elect to apply the 50% bonus rate in place of the 100% rate to all qualified property acquired and placed in service after September 28, 2017 during the taxpayer’s tax year that includes September 28, 2017. Taxpayers should be allowed to make or revoke this election if they placed QIP in service in 2018 during a 2017/2018 fiscal year and used the 39-year recovery period.
For additional information see the following CCH Answer Connect explanations:
By Ray G. Suelzer, J.D., LL.M.