The Tax Cuts and Jobs Act (TCJA) was a major overhaul of the U.S. Tax Code passed in 2017. Of course, 2017 seems like decades ago considering all that has transpired since then, most notably the coronavirus pandemic. Unfortunately, it took a worldwide catastrophic event like the pandemic to prompt a correction to a well-known drafting error in the TCJA.
One provision of TCJA is related to the capitalization and depreciation of certain improvements to the interior of buildings. The Act provided a definition of Qualified Improvement Property (QIP) as improvements made by a taxpayer to the interior of a building that is nonresidential real property, completed after the date the building is placed in service. QIP does not include expenditures for the enlargement of the building, elevators or escalators, or the interior structural framework of the building.
Although the law defined QIP, it offered no further guidance on what exactly to do with it. The intent of Congress was to make QIP eligible for 15-year straight-line depreciation but also eligible for 100% bonus depreciation. In other words, the intent was for the taxpayer to be able to write off the cost of QIP in the year the improvements were made. However, without explicitly stating that treatment in the actual law, taxpayers were stuck continuing to depreciate property according to existing law, which meant using a 39-year depreciation period in most cases. This also meant that the property was not eligible for bonus depreciation.
So what’s the difference? Let’s assume that a taxpayer completed and placed-in-service $100,000 of QIP in 2018. Prior to the passage of the Coronavirus Aid, Relief and Economic Security (CARES) Act, that $100,000 would have to be depreciated over 39 years which results in about a $2,500 tax deduction each year. That equates to about a $625 reduction in federal tax, assuming a 25% tax rate. Now, take that same $100,000 and take 100% bonus depreciation (i.e. deduct the entire $100,000 in 2018). That will yield a $25,000 reduction of the amount of tax paid, using the same tax rates. The taxpayer in this example defers over $24,000 in taxes by making this change. This is a deferral since the taxpayer would eventually have gotten that full deduction, but it would have taken 39 years to do so.
Fast forward to 2020 and the CARES Act. Congress finally corrected their previous error from TCJA and provided the intended treatment of QIP. Retroactive to 2018, QIP now has a 15-year depreciable life and, perhaps more importantly, is eligible for 100% bonus depreciation. What this means is that if you have already filed a 2018 and/or 2019 tax return using a 39-year life for assets that should be defined as QIP, you can make a change to effectively accelerate the depreciation on those assets and potentially get a refund on taxes paid in those years.
There are several options for taking advantage of this new provision. Contact your tax advisor to find out whether your business qualifies.
John R. McCallum, CPA
John R. McCallum is a member with GranthamPoole PLLC and a recognized leader in the field of cost segregation and various real estate taxation matters. He has also written, taught, and spoken on many topics in the area over the years. Please contact John at jmccallum@granthampoole.com, www.linkedin.com/in/john-mccallum, or 601-499-2400. CPA License # 5323
The above does not represent tax advice. Each situation is fact-dependent, and you should seek the advice of a competent advisor. GranthamPoole PLLC is a provider of tax, accounting, advisory and strategic services, partnering with clients across a broad spectrum of industries and sizes.