In December 2017, the Tax Cuts and Jobs Act of 2017 (TCJA) was enacted, bringing forth significant changes in individual and business taxation. One area of anticipated change involved giving businesses the ability to immediately deduct certain improvements made to the interior of their nonresidential buildings. Although congressional drafters intended to make this change, it was inadvertently omitted from the final version of the TCJA. This oversight, which was thought to have the most impact on the retail and restaurant industries, became known as the “retail glitch.” When the Coronavirus Aid, Relief, and Economic Security (CARES) Act was signed into law on Friday, March 27, 2020, this omission was corrected, thereby giving businesses in all industries, not only retail and restaurant, the ability to potentially benefit from this new provision.
Qualified Improvement Property Defined
As part of the TCJA, Internal Revenue Code Section 168 was amended, allowing taxpayers to deduct 100 percent of the costs incurred for certain qualified property. This “100 percent bonus depreciation” applies to several categories of qualifying property, including property with a depreciation recovery period of 20 years or less. In addition, the TCJA eliminated several tax-advantaged categories of building improvement assets (i.e., qualified leasehold improvement property, qualified restaurant property and qualified retail improvement property) and replaced them with a single category referred to as qualified improvement property.
Qualified improvement property (QIP) is defined in the TCJA as any improvement to the interior of a nonresidential building (if the improvement is placed in service after the date such building was first placed in service), but excludes expenditures for the enlargement of the building, any elevator or escalator and the internal structural framework of the building.
The “glitch” occurred when QIP was excluded from the list of 15-year assets in Code Section 168, which would have made it eligible for 100 percent bonus depreciation because its recovery period would have been less than 20 years. When QIP was excluded from the list, by default it was treated as a 39-year asset and, therefore, not eligible for 100 percent bonus depreciation. The CARES Act corrected this mistake by including QIP on the list of 15-year assets, thereby making it eligible for 100 percent bonus depreciation.
What This Means for Taxpayers
The ability to take 100 percent bonus depreciation instead of depreciating an asset over 39 years is highly preferable for most businesses. For example, a $1 million expenditure depreciated over 39 years results in approximately $25,641 of depreciation deductions per year for the next 39 years; contrasted with 100 percent bonus depreciation for the same $1 million expenditure that results in $1 million of depreciation deductions in the first year. This provides businesses with an immediate return on their investment and allows them to take advantage of the time value of money.
In correcting this mistake, the CARES Act applied the change prospectively and retroactively to the effective date of the TCJA. This means QIP placed in service after Dec. 31, 2017, and before Jan. 1, 2023, is now eligible for 100 percent bonus depreciation (under current law, the bonus depreciation rate gradually decreases beginning in 2023 and eventually expires on Jan. 1, 2027). Businesses that incurred eligible QIP expenditures during the 2019 tax year (or an eligible future tax year) can simply record them as 15-year assets and apply 100 percent bonus depreciation, resulting in a dollar-for-dollar first-year deduction of those costs (assuming the 2019 return has not yet been filed). Businesses that incurred eligible QIP expenditures during the 2018 tax year and recorded them as 39-year assets on a previously filed return can change those assets to 15-year assets and take 100 percent bonus depreciation by either:
- Amending the 2018 return, or
- Filing Form 3115 (Application for Change in Accounting Method) and attaching the form to the current-year return.
For businesses that incurred eligible QIP expenditures during the 2019 tax year and have already filed their 2019 return, this correction can be made through the filing of a superseding return prior to their extended filing deadline.
By correcting the “retail glitch,” the CARES Act rectifies a clear error in the drafting of the TCJA and allows businesses that perform eligible improvements to their buildings to immediately deduct the costs associated with those improvements. Not all building improvements are eligible for this beneficial treatment, however. If you have any questions or would like help determining your eligibility, please contact your Clark Schaefer Hackett's Brendan Walsh (bjwalsh@cshco.com).
