April 24, 2019
Qualified Improvement Property and the 2017 Tax Revision
(P.L. 115-97)
The major tax revision (P.L. 115-97) enacted at the end of
Current tax law contains two provisions that allow firms to
2017 made significant changes in the options available to
expense (or deduct as a current cost) part or all of the cost
companies for recovering the cost of many of the
of eligible assets in the year they are first placed in service.
depreciable capital assets they use in their businesses. One
Section 179, which applies to machinery and equipment,
such asset was certain improvements to nonresidential real
computer software, and selected nonresidential real
estate, known as qualified improvement property (QIP).
property (including improvements to such property), allows
While the law allowed the cost of assets other than
companies to expense a limited amount of the cost of
buildings to be fully expensed (i.e., treating the cost as a
qualified assets in the year when they are placed in service.
current expense, not a capital expense), the cost recovery
For the 2018 tax year, the allowance was capped at $1
period for QIP was unintentionally extended through what
million, an amount that began to phase out dollar-for-dollar
some have called the “retail glitch,†making the property
when a company’s total spending on qualified assets
ineligible for this treatment.
exceeded $2.5 million.
Under an income tax, companies are allowed to deduct the
The other provision is a 100% expensing allowance under
ordinary and necessary expenses they incur in producing
Section 168(k) known as the bonus depreciation allowance.
income. Many of these expenses are for inputs whose value
For the most part, it applies to tangible assets with a
does not extend beyond the year when they are used (e.g.,
depreciation life of 20 years or less under the MACRS. The
worker compensation and materials). But some inputs retain
current allowance covers 100% of the cost of qualified
their value longer than the year they are first used.
assets placed in service between September 28, 2017, and
Examples include machines, motor vehicles, and factory
December 31, 2022. This allowance is scheduled to
buildings. The proper approach to recovering their cost is to
decrease to 80% of the cost of qualified assets in 2023, 60%
gradually recover it through deductions for the decline in
in 2024, 40% in 2025, and 20% in 2026; it is not available
their value over time. This decline in value is known as
for tax years beginning in 2027 and thereafter.
depreciation and typically stems from wear and tear or
obsolescence in the use of a depreciable asset. Deductions
Depreciation for Qualified Improvement Property
for depreciation usually are taken over three or more years
Among the assets subject to depreciation for tax purposes
under the federal income tax, until the original cost of an
are certain improvements that businesses make to the
asset has been recovered.
interior space they occupy of nonresidential buildings. The
improvements can be made by leaseholders, or by owners
Depreciation that reflects the actual decline in the market
of the structures. They can take many forms, such as
value of an asset from year to year is known as economic
installing new lighting and carpet in a leased office, adding
depreciation. When used as the basis for recovering the cost
new woodwork and windows to the dining room of a
of depreciable assets for tax purposes, economic
restaurant, and painting the walls and upgrading the sound
depreciation promotes neutrality in the impact of an income
system of a retail store.
tax on investment in those assets. In practice, the
difficulties and cost of measuring the actual decline in the
Legislative Background
market value of an asset mean that most systems for
Before the passage of the American Jobs Creation Act of
depreciating the cost of assets for tax purposes deviate from
2004 (AJCA; P.L. 108-357), the cost of improvements to
economic depreciation for most assets.
nonresidential real property was generally recovered over
39 years, which was the recovery period for the property
Current Depreciation for Tangible
itself under the MACRS. This treatment reflected a long-
Assets
standing tax rule that additions or improvements to
There are two systems for depreciating tangible assets
nonresidential real property should be depreciated over the
under current law: (1) the modified accelerated cost
same period as the real property.
recovery system, or MACRS (§168 of the federal tax code);
and (2) the slower alternative depreciation system, or ADS
AJCA lowered the recovery period for both “qualified
(§167). The former is accelerated relative to the latter,
leasehold improvement property (QLP)†and “qualified
which is thought to be a better approximation of the rate of
restaurant improvement property (QRP)†to 15 years,
economic depreciation for the tangible depreciable assets
making them eligible for the 50% bonus depreciation
covered by each system. The MACRS allows shorter
allowance that was available when this change in recovery
depreciation lives and depreciation schedules that make it
period went into effect on October 23, 2004. Improvements
possible for firms to write off more of an asset’s cost early
to leasehold property qualified for the 15-year recovery
in its recovery period.
period if they were made according to the terms of a lease
https://crsreports.congress.gov
Qualified Improvement Property and the 2017 Tax Revision (P.L. 115-97)
by the lessee or the lessor, were placed in service more than
The language of the bill as signed into law, however,
three years after the building was first placed in service, and
omitted any reference to assigning a 15-year recovery
did not enlarge the building, install or upgrade elevators or
period to QIP. It is unclear why this happened, but it
escalators, or alter the building’s “internal structural
appears that Congress intended to establish a 15-year tax
framework.†Improvements to restaurant property were
life for the property under MACRS. According to the
depreciable over 15 years if they were placed in service
Conference Agreement for H.R. 1 (H.Rept. 115-466, p.
more than three years after the building was first placed in
367), there was to be “a general 15-year MACRS recovery
service, and at least 50% of the building’s interior space
period for qualified improvement property.†Unless
was used for food preparation and dining on the premises.
Congress passes a technical correction to the law, QIP will
The cost of QLP and QRP had to be recovered using the
generally be subject to a 39-year cost recovery period.
straight-line method of depreciation, which meant that the
Moreover, without such a correction, QIP is ineligible for
same amount of the cost was deducted in each year of the
the bonus depreciation allowance under Section 168(k). But
recovery period.
QIP does qualify for the Section 179 expensing allowance.
Congress created a separate category for “retail
Companion bills have been introduced in the House (H.R.
improvement property (QREP)†and assigned a 15-year tax
1869) and Senate (S. 803) to make QIP eligible for the
life to qualified property placed in service starting in 2009.
expensing allowance by assigning it a 15-year MACRS
The legislative vehicle for the change was the Tax
recovery period and a 20-year ADS recovery period. The
Extenders and Alternative Minimum Tax Relief Act of
proposals come against a backdrop of complaints from
2008 (Division C of P.L. 110-343). Property qualified for
owners and lessors/lessees of retail stores, office space, and
this treatment if it involved one or more improvements to
restaurants about the financial disadvantages of using a 39-
the interior of a nonresidential building; the building’s
year cost recovery period for property improvements.
interior was open to the general public and used primarily
for selling tangible personal property to the general public;
Accelerated Depreciation and Investment in
and the improvement was placed in service more than three
Qualified Improvement Property
years after the building was first placed in service. Such
Why does the tax treatment of depreciation for QIP matter
property had to be depreciated using the straight-line
to business owners? The answer lies in the potential
method. QREP was eligible for partial expensing under
benefits of accelerated depreciation for companies investing
Section 168(k).
in affected assets.
The Protecting Americans from Tax Hikes Act of 2015
In theory, accelerated depreciation is a form of tax deferral.
(P.L. 114-113) permanently extended the 15-year recovery
While it does not alter the total amount of depreciation
period for QLP, QRP, and QREP. It also established a
allowances a company can take for an asset, it does defer
fourth category of improvement property known as
the payment of income tax on the returns from investing in
qualified improvement property (QIP). QIP was defined as
the asset. This is because the allowances are taken earlier
an improvement to the interior of a nonresidential building
than they would be under economic depreciation. The
that did not involve enlarging the structure, upgrading or
company is better off, since a dollar received today is worth
installing elevators or escalators, or modifying its internal
more than a dollar received in a future year. Companies
structural framework. In addition, the property only had to
benefit from accelerated depreciation through (1) the
be placed in service after the building was placed in service,
interest they could earn on deferred taxes, (2) a reduction in
and it did not have to involve a lease. The tax life for QIP
tax liability from the net present value of deferred taxes, (3)
was set at either 15 years or 39 years. The 15-year recovery
an increase in the after-tax rate of return on an investment,
period applied only if the improvement property met the
and (4) a decline in the effective tax rate on the returns from
requirements for QLP, QRP, or QREP. As with the other
that investment. This suggests that accelerated depreciation
categories of improvement property, the straight-line
has the potential to boost investment in an asset by lowering
method had to be used in recovering the cost of QIP; it
the user cost of capital for the investment, and by increasing
qualified for the Section 168(k) expensing provision only if
the cash flow of companies making such an investment.
it could be depreciated over 15 years.
It can be argued that current tax law inadvertently
Impact of P.L. 115-97
discourages investment in QIP through its treatment of
The major tax revision enacted in late 2017 (P.L. 115-97)
depreciation for the property. This is because the property is
accelerated the depreciation of most assets except for
not eligible for the benefits of accelerated depreciation. A
nonresidential real estate. In addition, it modified the
39-year recovery period with no bonus depreciation means
depreciation rules for improvement property. Specifically, it
a higher user cost of capital for investment in QIP and
consolidated the four previous categories of improvement
lower cash flow, relative to 100% or 50% bonus
property into a single category called QIP. This treatment
depreciation with a 15-year recovery period.
applied to tax years beginning in 2018 and thereafter. The
definition of QIP stayed the same from previous tax law.
Gary Guenther, Analyst in Public Finance
IF11187
https://crsreports.congress.gov
Qualified Improvement Property and the 2017 Tax Revision (P.L. 115-97)
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