Cost Segregation and Tax Reform: Qualified Improvement Property
By Joseph Strickland
August 23, 2019
The 2017 Tax Cuts and Jobs Act (TCJA) made changes to qualified property definitions and the application of bonus depreciation that, for the most part, were regarded as positive.
One anticipated modification was elimination of the qualified leasehold improvement, restaurant property, and qualified retail improvement asset classes, combining them into one category called qualified improvement property (QIP).
The intent was to assign a 15-year recovery period to this now all-inclusive QIP asset category which would qualify QIP to receive bonus depreciation. However, the statute, as drafted, inadvertently neglected to assign a 20-year class life (which would equate to a 15-year recovery period) to QIP.
QIP is defined as any improvement to an interior portion of a building which is nonresidential real property, if the improvement is placed in service after the date the building was first placed in service. Expenditures which are attributable to the enlargement of a building, installations of elevators or escalators, or changes to the structural framework of the building are excluded.
Although Congress intended QIP to have a 15-year recovery period and qualify for bonus depreciation, because of the drafting oversight, tax returns should treat QIP as having a 39-year life and, therefore, not qualify for bonus depreciation. A bipartisan bill has been introduced that would fix this error; but as of now, no date has been set to make this technical correction.
A cost segregation study performed now can help a taxpayer maximize current depreciation, as well as segregate the QIP from the structural, exterior, and other non-qualified property. This allows the taxpayer to correctly identify the QIP that would qualify for a 15-year life and bonus depreciation if/when this eagerly anticipated technical correction is signed into law. Additionally, the study would further segregate out any personal property and land improvements which, in addition to their shorter tax lives, are generally eligible to receive bonus depreciation under the new tax law.
For example, we performed a study on a tenant fitout that began construction in 2018 and was placed in service in 2019. The results of the study were as follows:
Even with the oversight in the current Code, the cost segregation study identified an additional $3.1 million in bonus depreciation and a net present value savings of approximately $861,093 by segregating out the personal and land improvement property. The study also segregated the QIP from the non-residential real property.
Should a correction be made to the Code that allows capturing the savings retroactively, the taxpayer will be able to easily identify the QIP property and collect an additional $5 million in bonus depreciation resulting in a net present value savings of approximately $2.2 million.
Please contact your Mazars USA LLP tax professional for additional information.