CARES Act: Technical Correction for Qualified Improvement Property Provides Retroactive Tax Relief

This tax release was updated on April 22, 2020 to include a discussion of recently issued guidance which intersects with the CARES Act technical correction for qualified improvement property

The CARES ACT provides a long-awaited technical correction for qualified improvement property (QIP), enabling taxpayers to claim 100% bonus depreciation on eligible QIP. The amendments are retroactive to the effective date of the Tax Cuts and Jobs Act (TCJA) and are applicable to property placed in service on or after January 1, 2018. Although the TCJA had intended QIP to qualify for bonus deprecation, an error in drafting the legislation erroneously classified QIP as 39-year property making it ineligible for bonus depreciation beginning January 1, 2018. This oversight required a technical correction in order to align with Congressional intent of the TCJA provisions. Taxpayers may file a Form 3115, Application for Change in Method of Accounting, to reflect the cumulative amount of QIP bonus depreciation to which the taxpayer is now entitled. It is also expected that Treasury and IRS will issue additional guidance related to amending tax returns and filing accounting method changes related to QIP, which may provide taxpayers with additional procedural alternatives.

CARES Act Amendments

The CARES Act amended Sec. 168 to classify QIP as 15-year property under MACRS, with a 20-year class life under ADS. The Act also amended the definition of “qualified improvement property” to clarify that such improvements must be made by the taxpayer in order to qualify (i.e., the definition of QIP does not include improvements made by a prior owner). As a result, used or acquired improvements do not qualify for the 15-year recovery period or for bonus depreciation. Any improvements that do not qualify will continue to be subject to a 39-year recovery period.

The amendments made as part of CARES Act are applicable to property placed in service on or after January 1, 2018. For property placed in service before January 1, 2018, the applicable property already qualifies for bonus depreciation. After enactment of TCJA, it was initially unclear how the bonus depreciation provisions applied to property that was placed in service after September 27, 2017, but before January 1, 2018 and that was previously eligible (qualified leasehold improvement property, qualified retail improvement property, and QIP) for bonus depreciation. IRS and Treasury confirmed that the removal of qualified leasehold improvements (QLIP), qualified retail improvement property (QRIP), and qualified restaurant (QRP) property definitions from Sec. 168 was applicable for property place in service after December 31, 2017. Further, they confirmed that QIP was not removed from the definition of bonus-eligible property until after December 31, 2017. As a result, property placed in service on or before December 31, 2017 and classified as QLIP, QRIP, or QIP was eligible for bonus depreciation (100% or 50%, depending on the acquisition date).

Differences between the August 2018 proposed bonus depreciation regulations and September 2019 final and proposed regulations may create additional opportunities for 100% bonus depreciation with respect to QLIP, QRIP, QIP and other types of bonus-eligible property placed in service after September 27, 2017. Guidance regarding the transition from the August 2018 proposed regulations to the September 2019 final and proposed regulations for property placed in service in prior years is still pending.

Correcting Previously Filed Returns

Taxpayers will need to correct the depreciation of QIP assets on previously filed tax returns to reflect bonus depreciation, or the appropriate depreciation using a 15-year recovery period (MACRS) or 20-year recovery period (ADS).

• Amend Tax Return. With the statute of limitations still open for 2018, taxpayers may file an amended tax return to correct the recovery period and claim 100% bonus depreciation, if applicable, on QIP property that was placed in service during 2018. Taxpayers that made an election out of bonus depreciation for 15-year property will not be eligible to claim bonus depreciation. It is possible that IRS will issue transition guidance that would allow the revocation of such an election, but no such guidance has been provided yet.

A partnership subject to the BBA partnership audit rules will be required to file an administrative adjustment request (AAR) instead of filing an amended return. For these partnerships, it may be advisable to file a Form 3115 instead of an AAR.

• File a Form 3115, Application for Change in Method of Accounting. Alternatively, taxpayers have the option to file a Form 3115 under the automatic consent procedure in order correct the recovery period on QIP and to claim 100% bonus depreciation, where applicable. The accounting method change can be filed with the tax return for the selected year of change (e.g., 2019 or 2020). The method change would be implemented with a Sec. 481(a) adjustment and thus the cumulative amount of additional depreciation for prior years would all be deducted on the tax return for the year of the change.

Net Operating Losses

The additional depreciation deductions generated by filing an amended return or Form 3115 may create or increase a net operating loss (NOL) position for 2018, 2019 or 2020 that could be carried back up to five years under the CARES Act. Taxpayers should evaluate NOLs and potential refund claims when determining which avenue to pursue, and if filing a Form 3115, which year in which to make the change.

Business Interest Expense Limitations

Taxpayers that made an election out of the business interest limitation under Sec. 163(j) as an electing real property trade or business are required to use the 20-year ADS depreciation period for QIP and are not eligible for bonus depreciation for QIP. Taxpayers may have made the election based on the assumption that QIP would not be eligible for bonus depreciation and the QIP correction may change the economics of this analysis. The election out of Sec. 163(j) for real property trades or businesses, once made, is irrevocable. It is not currently known when, or if, IRS may provide relief allowing such elections to be revoked.

The Takeaway

The correction made by the CARES Act for QIP provides a significant opportunity for taxpayers to generate additional tax deductions, possibly resulting in NOLs with a five-year carryback, and increase cash flow. Taxpayers should consider whether to implement the technical corrections by amending their 2018 tax return or filing a Form 3115 for a subsequent year. Treasury and IRS are expected to issue additional guidance which may provide different alternatives for correcting depreciation for QIP retroactively. Careful consideration is required as it may have an impact on other areas of the tax return, such as the Sec. 163(j) interest limitation and NOL generation or utilization. Andersen’s accounting methods specialists are prepared to assist with analysis and to identify appropriate strategies.