The Tax Cuts and Jobs Act of 2017 brought significant changes to the depreciation of qualified improvement property (QIP). The changes, effective from 2018, have impacted businesses that own or lease commercial buildings. In 2023, as we approach the fifth year of these changes, understanding how they affect QIP depreciation is crucial for businesses to optimize their tax strategies.
Qualified improvement property refers to any improvement made by the taxpayer to an interior portion of a nonresidential building if the improvement is placed in service after the building was first placed in service. However, the improvement must be made pursuant to a plan to make such improvement at the time the building was first placed in service, or before the improvement was placed in service.
Changes in Depreciation Period
The pre-2018 tax law treated QIP as 15-year property, eligible for accelerated depreciation. However, the 2017 Act inadvertently left out QIP from favorable 15-year depreciation and classified it as 39-year property, subject to straight-line depreciation.
The error was rectified in the Coronavirus Aid, Relief, and Economic Security (CARES) Act of 2020, which retroactively restored 15-year depreciation for QIP placed in service after 2017. This change applies to 2023 as well, benefiting businesses that have QIP with 15 years of depreciation left.
Retroactive Application
Thanks to the CARES Act, businesses can retroactively apply the 15-year depreciation to QIP placed in service after 2017. They can file a taxable income adjustment for the open tax years to receive a refund or reduce their tax liability.
To do so, businesses need to file Form 3115 with their tax return to claim the change in method of accounting. The deadline for filing Form 3115 for QIP placed in service after 2017 and before 2020 is the due date (including extensions) of the taxpayer's return for the year the QIP was placed in service.
Bonus Depreciation
In addition to the change in the depreciation period, the 2017 Act also increased bonus depreciation rates. For QIP placed in service after 2017, 100% bonus depreciation is allowed. This means businesses can write off the full cost of the QIP in the year it was placed in service.
However, the Taxpayer Certainty and Disaster Tax Relief Act of 2019 modified the 15-year recovery period to apply to QIP placed in service after 2017 and before 2023. This change effectively ended 100% bonus depreciation for QIP placed in service after 2022. Businesses should take this into account when planning their 2023 tax strategies.
Differences in State Tax Law
While the federal law has been clarified, state tax laws regarding QIP depreciation vary. Some states have conformed to the federal law changes, while others have not. Businesses should consult their state's tax law and seek professional advice to ensure compliance.
It's important to note that some states may not allow the retroactive application of the 15-year depreciation. Therefore, businesses should be aware of the specific requirements and potential changes in their state's tax law.
As we head into 2023, businesses should consider how the changes in QIP depreciation rules will affect their tax strategies. Consulting with a tax professional can help ensure businesses are maximizing their deductions and minimizing their tax liability. Correctly navigating the tax laws will not only benefit businesses in the short term but also foster long-term tax planning strategies.
