Qualified improvement property and CARES Act retroactive changes

A provision in the CARES Act treats qualified improvement property (QIP) as 15-year property, making it once again eligible for 15-year MACRS depreciation or bonus depreciation.

August 24, 2020

A provision in the CARES Act treats qualified improvement property (QIP) as 15-year property, making it once again eligible for 15-year MACRS depreciation or bonus depreciation. Affected taxpayers who previously treated QIP as 39-year property have several options for correcting depreciation for 2018 and 2019.

Background on bonus depreciation and the “retail glitch”

The TCJA allowed 100% additional first year “bonus” depreciation for qualified property acquired after September 27, 2017 and placed in service after December 31, 2017.

The TCJA also grouped qualified leasehold improvement property, qualified restaurant property, and qualified retail improvement property in a category called qualified improvement property, or QIP. However, the Act did not provide a 15-year recovery period for QIP. Consequently, QIP defaulted to the 39-year recovery property for nonresidential rental property. The so-called retail glitch also made QIP ineligible for bonus depreciation, which is generally allowed only for property with a class life of 20 years or less.

The CARES Act and QIP

The CARES Act provides a technical correction to the TCJA by designating QIP as 15-year MACRS property. Also, QIP is assigned a 20-year recovery period for the alternative depreciation system (ADS). This change is in effect as if it had been included in the TCJA. As a result, QIP acquired after September 27, 2017 and placed in service after December 31, 2017 is eligible for 100% bonus depreciation. The CARES Act provision thus “fixes” the retail glitch.

The Treasury Department and IRS provide guidance in Rev. Proc. 2020-25 for handling this retroactive change. The revenue procedure permits taxpayers to:

  • File amended returns, or
  • File Form 3115 Application for Change in Accounting Method, or
  • Make an Administrative Adjustment Request (AAR) for tax year 2018, 2019, or 2020. (See the next section for an AAR example.)

For 3115 purposes, the change is treated as an automatic §481(a) adjustment changing from an impermissible to a permissible depreciation method.

Example: DDT Co. placed $25,000 of QIP in service during 2018 and claimed depreciation deductions of $400 in 2018 and $600 in 2019. DDT may now amend its 2018 return to claim the full $25,000 bonus depreciation deduction. If amending 2018, the company would also have to amend its 2019 return to remove the $600 depreciation deduction claimed for that year. DDT could instead wait to claim the $24,000 remaining deprecation on its 2020 return filed in 2021 using 3115 procedures.

Alternatively, DDT could amend its 2018 and 2019 returns or use 3115 procedures to elect out of bonus depreciation and instead claim depreciation based on the 15-year instead of the 39-year recovery period.

These procedures do not apply to:

  • Certain large retail trade or businesses and large farm businesses that made or withdrew elections regarding the §163(j) interest expense limitation (discussed later), and
  • Property that was already expensed, for example, under the de minimis safe harbor rules.

Rev. Proc. 2020-25 also provides automatic extensions of time for making, revoking, or withdrawing several §168 elections for QIP property placed in service in 2018, 2019, or 2020:

  • The §168(k)(7) election not to deduct bonus depreciation.
  • The §168(k)(10) election to deduct 50% instead of 100% bonus depreciation for property acquired after September 27, 2017 and place in service during a tax year that includes September 28, 2017 (tax year 2017 for calendar year taxpayers).
  • The §168(g)(7) election to use the ADS for property placed in service during the taxable year.
  • The §168(k)(5)(A) election regarding depreciation rules for specified plants in a farming business.

In general, taxpayers who filed timely tax returns or Form 1065 for tax years 2018, 2019, or 2020 have until October 15, 2021 to make or revoke these elections.

Rev. Proc. 2020-25

Originally published in the April 29, 2020 edition of TAX in the News.

See this Insights article for more information on CARES Act changes "New rules for NOLs under CARES Act"

 

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