IRS Releases QIP Guidance: the CARES Act and Revenue Procedure 2020-25
The Coronavirus Aid, Relief, and Economic Security (CARES) Act was enacted on March 27, 2020 and included many economic relief measures as summarized in previous True Alerts (Tax Issues Addressed by COVID-19 Emergency Legislation; Congressional Action on the COVID-19 Pandemic: The CARES Act). This True Alert will focus on a technical correction to the eligibility of qualified improvement property (QIP) for additional first-year bonus depreciation.
QIP is a relatively new asset classification created by the Protecting Americans from Tax Hikes (PATH) Act of 2015. Prior to the Path Act, most taxpayers could only claim bonus depreciation or Section 179 deductions on real property improvements that met the definition of “qualified leasehold improvement property.” This asset category included improvements made under a lease to an interior portion of a nonresidential building after the building was first placed in service, with certain exceptions. QIP broadened the scope of qualifying property by eliminating restrictions on owned property as well as improvements made within the first three years after a building is first placed into service.
The Tax Cuts and Jobs Act (TCJA) intended for QIP placed in service after December 31, 2017 to have a 15-year recovery period. However, due to a legislative drafting error commonly known as the “Retail Glitch,” QIP defaulted to a 39-year recovery period. This error meant that QIP was ineligible for bonus depreciation which only applies to assets with a recovery period of 20-years or less. Further, the IRS subsequently issued final Section 168(k) regulations on September 24, 2019 affirming the position that QIP was 39-year property and ineligible for bonus depreciation.
The CARES Act provides the technical correction to the Retail Glitch by classifying QIP as 15-year property and thus eligible for bonus depreciation. The amendments made by the CARES Act are retroactive to the effective date of the TCJA, making QIP eligible for 100% bonus depreciation if the QIP is placed in service after December 31, 2017, and before December 31, 2022.
Identifying Qualified Improvement Property Assets
QIP is defined in Section 168(e)(6) as “any improvement made by the taxpayer 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.” QIP is defined broadly by both the Code and accompanying Regulations. Improvements meeting the definition of QIP include:
- Interior Doors
- Interior AC/HVAC
- Interior Water Heaters
- Interior Security Upgrades
- Interior Fire Protection Systems
- Interior Electrical
- Interior Waterlines/Pluming
- Interior Painting
However, the following improvements are expressly excluded from the definition of qualified improvement property:
- The enlargement of a building
- Defined in Treasury Regulation §1.48-12(c)(10) which states that a “building is enlarged to the extent that the total volume of the building is increased. An increase in floor space resulting from interior remodeling is not considered an enlargement.”
- Any elevator or escalator
- Defined in Treasury Regulation §1.48-1(m)(2) as “a cage or platform and its hoisting machinery for conveying persons or freight to or from different levels and functionally related equipment which is essential to its operation. The term includes, for example, guide rails and cables, motors and controllers, control panels and landing buttons, and elevator gates and doors, which are essential to the operation of the elevator.”
- The internal structural framework of a the building
- Defined in Treasury Regulation §1.48-12-(b)(3)(iii) as including “all load-bearing internal walls and any other internal structural supports, including the columns, girders, beams, trusses, spandrels, and all other members that are essential to the stability of the building.”
Administrative Matters – How to Claim a Retroactive Benefit
On April 17, 2020, the IRS released Revenue Procedure 2020-25 providing guidance which allows taxpayers to change their depreciation method under Section 168 for QIP placed in service after December 31, 2017 during its taxable years ending in 2018, 2019 or 2020. The revenue procedure also allows taxpayers to make a late election, or to revoke or withdraw an election under Sections 168(g)(7),(k)(5),(k)(7) or (k)(10) for the taxpayer’s 2018, 2019 or 2020 tax years.
Under Revenue Procedure 2020-23, taxpayers are given the option to either file an amended return to claim the bonus depreciation, file an administrative adjustment request under Section 6227 (AAR) for partnerships, or file Form 3115, Application for Change in Accounting Method.
To aid taxpayers looking to change their method of accounting for QIP, Revenue Procedure 2020-25 provides a reduced filing requirement for Form 3115. It is important to note that these reduced filing requirements are strictly for the additional bonus depreciation taken on QIP assets.
In addition, Revenue Procedure 2020-25 specifically grants taxpayers an extension of time to revoke, withdraw, or make a late election with respect to QIP placed in service on a 2018, 2019 or 2020 tax return that was filed prior to April 17, 2020. The extension applies specifically for elections to:
- Use the alternative depreciation system (ADS) under Section 168(g)(7);
- Claim additional depreciation for plants placed in service in connection with a farming business under Section 168(k)(5);
- Elect out of the additional first-year depreciation under Section 168(k)(7); or
- Elect to apply a 50% first-year additional depreciation instead of the 100% under Section 168(k)(10).
The revocation of elections made under Sections 168(k)(5), (7), or (10) may be made by filing Form 3115, an amended tax return, or an AAR in the case of partnerships. The withdrawal of the ADS election under Section 168(g)(7) can only be made by filing an amended tax return or by filing an AAR.
The correction set forth by the CARES Act has created an opportunity for increased deductions for taxpayers with QIP. Coupled with the 5-year carryback of net operating losses generated in 2018, 2019, and 2020, some taxpayers may be able to monetize 100% expensing of QIP at pre-TCJA tax rates. In order to determine if a taxpayer qualifies for the additional first-year depreciation deduction, a study should be conducted to determine assets that may qualify and how to best implement the change. Taxpayers should also consider and evaluate the impact of these changes on other tax positions in their tax returns including interest limitations, BEAT, FDII, and FTCs.
Please contact a member of your TPC engagement team if you have additional questions about this topic or to learn more about how we can help you maximize your company’s benefits from QIP.