With the recently enacted CARES Act, Congress has finally corrected a drafting error they made when they passed the Tax Cuts and Jobs Act (TCJA) at the end of 2017. Congress clearly indicated that the TCJA was supposed to accelerate the depreciation of “Qualified Improvement Property” (QIP), but, as drafted, the law did not accomplish that. QIP is defined as any improvement made by the taxpayer to the interior portion of a nonresidential building, and thereby impacts many retail and commercial businesses. In order to count as QIP, such improvements must be made after the building is placed in service. QIP does not include structural work, elevators, escalators, or an enlargement of the building.
In TCJA, Congress mistakenly left the depreciable life of QIP at 39 years, instead of the planned reduction to 15 years. This error was compounded, since by retaining the longer depreciation life, QIP was not eligible for the 100% bonus depreciation (which is allowed only on property with a depreciable life of 20 years or less). The CARES Act changes this by retroactively granting QIP the intended shorter 15-year life, and thus also makes QIP eligible for 100% bonus depreciation write-off. While this change is retroactive to 2018, most taxpayers have already filed their 2018 tax returns, and many have also filed their 2019 returns.
The IRS has provided guidance to help taxpayers navigate this change and has issued procedures on how to take advantage of the changes to QIP depreciation. There are two primary methods to choose from: amending filed tax returns or filing for a change in accounting method going forward. Amended returns may be the preferred method for many, especially if the dollar amount of the QIP is significant.
The IRS considers the use of a specific depreciable life a “Tax Accounting Method”. They generally do not allow taxpayers to change an accounting method without first obtaining permission from the IRS, which can be an onerous task. Fortunately, the IRS has identified some changes that they deem to be automatically approved with the filing of a Form 3115-Change in Accounting Method. The change to the 15-year depreciable life for QIP is now one of these streamlined changes. One advantage of adopting the 15-year life for QIP as an accounting method change is that you can reap the benefits going forward without having to amend what has been filed.
Generally, a Form 3115 needs to be attached to an original timely-filed tax return; however, if you have already filed the 2019 tax return, there are some windows of opportunity specific to this change in law that may permit you to file a 3115 on a superseded or amended return filed within the next few months. The time is limited, so these opportunities need to be evaluated as soon as possible.
The decision whether to amend tax returns or to file for an accounting method change is complex and depends on various factors. For instance, if bonus depreciation on QIP creates a net operating loss that can be carried back to years where the tax rates were higher, the amended return approach may be the most beneficial, especially since the CARES Act allows for a 5-year carryback period. For small amounts of QIP, using the accounting change method may be easier and less costly. There are other factors to consider, including how quickly tax refunds are needed for cash flow and other provisions of the CARES Act that present refund opportunities that may also require amending prior year tax returns.
Please consult your tax advisor to evaluate the best way for you to take advantage of this new legislation.
