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Changes to Qualified Improvement Property: Have You Evaluated Your Potential Cash Savings?

It is odd to think it took a pandemic to fix a tax problem that Congress would not fix for over two years. In simple terms, Qualified Improvement Property (QIP) is an improvement made to the interior space of an existing Commercial Rental Property. The IRS has given beneficial tax treatment to QIPs, or their earlier tax forerunners such as Qualified Leasehold Improvements (QLI), since 2002. It was Congress’s intention that under the Tax Cuts and Jobs Act (TCJA), QIPs placed in service starting in 2018 were to be treated as 15-year property, and benefit from 100 percent Bonus Depreciation.

However, the TCJA writers made a mistake and wrote that QIP is 39-year property, and was not allowed to benefit from Bonus Depreciation. This oversight had huge negative tax effects to Real Estate Owners and Developers – instead of writing an expenditure off immediately (Congress’s intent), those costs had to be depreciated over 39 years (what the Tax Law says). To correct this oversight, a Corrections Act would have to be passed by Congress – and that has not happened for over two years, for several different political reasons.

Fortunately, the CARES Act retroactively corrects this tax problem. For QIPs placed in service starting in 2018, these assets will be treated as Congress originally intended: 15-year property, with the benefit of Bonus Depreciation.

To correct for this law change, taxpayers have two choices – amend or fix later. For a 2018 QIP, a taxpayer can either amend their 2018 tax return for this change (as long as they have not filed their 2019 tax return yet) or make the change on their 2019 or later returns by filing Form 3115 “Change In Accounting Method,” and pick up the missed depreciation. If the QIP occurred in 2019, and the taxpayer has filed their 2019 already, they can follow a similar approach – amend 2019, or correct in a future year.

So, what is a QIP? It is an improvement made to an existing commercial building (i.e. a 39-year property) that is:

  • Interior only (no improvements that touch the building’s outside such as a roof or outside HVAC).
  • That is not part of the Internal Structural Framework (i.e. stairs, beams, weight-bearing walls).
  • Not an expansion, elevator or escalator.
  • After the building has previously been placed in service by an owner sometime in the past. So, a taxpayer can purchase an existing property, renovate it before moving in, and still get QIP treatment.
  • The fact that the owner and tenant are related parties is not an issue (which is a change from the previous QLI rules).

Examples of a QIP could include:

  • Office renovations made to a recently purchased property for your business’s use.
  • A build-out for a tenant.
  • Remodeling a hotel to freshen the property.

However, the following renovations do not meet the QIP definition:

  • Apartment complexes and Skilled Nursing Facilities (since they are not commercial space).
  • Tenant Allowances paid to entice tenants do not qualify until the actual construction records are reviewed.
  • Taxpayers who must follow the Centralized Partnership (BBA) Rules or have made elections under Sec. 163(j) (Real Estate Exception rule) will have specific rules they will need to follow to take advantage of the new QIP treatment.

The Bonadio Group has worked on over 500 QIP Studies nationwide. Rarely does 100 percent of a taxpayer’s expenditure meet the QIP’s definition. Usually, 25 percent or more of the Real Estate Owner’s costs must be classified as something other than QIP. Why? HVAC is changed over, storefronts are renovated, buildings are painted, structural support is added, etc. But we know how to maximize a taxpayer’s savings, by applying tax ideas like the Repair Regulations, De Minimis, Sec. 179, and ADA tax benefits.

Please contact Roger Upton if you would like to discuss your particular situation. We look forward to hearing from you.

The information and advice we are providing for this matter relates to COVID-19 legislative relief measures. Because legislative efforts are still ongoing, we expect that there may be additional guidance and clarification from regulators that could modify some of the advice and information provided to you, after the conclusion of our engagement. We therefore make no warranties, expressed or implied, on the services provided hereunder.