8 minute read
In real property, different types of property that are purchased or installed can sometimes be depreciated at a faster rate than the larger structure or building it is attached to. One such property is what is called qualified improvement property. As the name suggests,qualified improvement property (QIP) relates to improvements to property, namely, nonresidential buildings such as retail buildings, hospitals, banks, manufacturing facilities, hotels, and motels. Residential property such as family homes, condos, townhomes, and apartments are considered non-qualifying realty.
There are certain conditions that must be met in order for the property to qualify as a QIP:
Qualified improvement property, when correctly identified, can be depreciated over 15 years. This is in contrast to the property that it is usually a part of, which would depreciate over 39 years. The larger nonresidential building would continue to depreciate at the straight-line method over 39 years, but the QIP will be depreciated using an accelerated method.
Under the Tax Cuts and Jobs Act, along with a technical correction in the CARES Act, QIP qualifies for 100% bonus depreciation until 2022. After 2022, the amount of bonus depreciation allowed will be reduced to 80% in 2023, 60% in 2024, 40% in 2025, 20% in 2026, until no bonus depreciation will be allowed in 2027. Again, per regulation, the expenditures for the improvement must occur after the building is purchased.
Qualifying property that is considered QIP includes:
Some expenditures can qualify in part. Regulations surrounding mixed-use realty properties are more complex because although they are technically designed for residential use, they are considered nonresidential buildings. For example, an apartment building with stores on the ground floor may qualify, to a degree, because a portion is solely dedicated to nonresidential use.
The favorable tax treatment accorded to qualified improvement property doesn’t reach the following:
It’s important to note that the definition of enlargement is specific under Treasury regulations. Under Treas. Regs. 1.48-12(c)(10), a “building is enlarged to the extent that the total volume of the building is increased. An increase in floor space resulting from interior remodeling is not considered an enlargement.” In other words, to count as an enlargement the building itself has to increase in size.
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Instead of an immediate deduction for QIP, taxpayers can choose a 15 year depreciation. A QIP is generally depreciated using straight-line. Straight line depreciation is the simplest method for calculating depreciation: (purchase cost – salvage value)/useful life assumption. However, QIP qualifies for special accelerated depreciation or expense, which will be discussed below.
When making use of tax projections it’s important to consider your personal context regarding tax brackets to determine if additional deductions will create losses. Historically, taxpayers with losses have been able to carry back losses and recover prior years’ taxes. This is no longer the case: current tax rules allow most taxpayers carryovers, not carrybacks, which may not be fully deductible. Additionally, tax rules governing Section 179 don’t allow you to create a loss with the deduction (Sec. 179(b)(3)).
Enlisting professional help may be helpful to ‘do the math’ to ensure you’re getting the most out of your tax deductions. This is because projections may include such factors as current and future tax brackets, upcoming retirement, state taxes and other factors that are important to you and may be more difficult to calculate accurately without professional help.
Planning for expenditures is essential to get the most out of your money, particularly when considering what does not apply. Certain expenditures that fall outside of the definition of QIP may also be outside of the definition of what qualifies for immediate expensing under Section 179 of the Tax Code. However, taxpayers may elect to treat the following as Section 179 property eligible for immediate expensing (Section 179(d)(1)(B)(ii) and (e)):
Rules under Section 179 are generous, but have their limits: in 2022 expensing has a limit of $1,080,000. While Section 179 also has its limits, many taxpayers will still be eligible to expense costs under its rules after 2022.
“Bonus depreciation” rules sometimes yield the same benefit as Section 179. Under the bonus depreciation rules, expenditures that may be fully deductible in 2022 will80% deductible in 2023 (Sec. 168(k)(6)). The ability to expense a QIP under the Section 179 rules has its dollar limits. However, it doesn’t take the same percentage approach as Section 168(k), which varies drastically.
A significant aspect of your tax planning process may involve weighing the Section 179 straight line approach to the Section 168(k) bonus depreciation approach. For additional help it’s a good idea to reach out to a tax professional as they'll be able to help determine the best choice for your circumstances.
Taxpayers may have missed opportunities for increased deductions in years prior to 2022, particularly because of the legislative error which has been retroactively corrected (See generally Rev. Proc. 2020-25).
QIP is a tax definition which can help you achieve faster deductions for improvements to nonresidential buildings. Faster expenses of depreciation allowances increases the present discounted value of the tax savings from depreciation compared to other depreciation methods. Properly understanding QIP can have a significant impact for real estate owners and investors.
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