Tax Depreciation of Qualified Improvement Property: Current Status and Legislative History

Tax Depreciation of Qualified Improvement Property: Current Status and Legislative History

Updated June 24, 2020
Tax Depreciation of Qualified Improvement Property: Current
Status and Legislative History
The federal income tax allows companies to deduct the
Depreciation of Qualified Improvement Property
ordinary and necessary expenses they incur in generating
Federal tax law regards the cost of certain improvements
taxable income. These expenses include the cost of assets
that leaseholders or owners make to the interior space of
whose value lasts beyond the year when they are first used,
nonresidential buildings as a capital expense. As a result,
such as machinery, motor vehicles, and factory buildings.
the cost of this improvement property is recovered through
The proper approach to recovering the cost of such assets is
allowable depreciation deductions. Improvement property
to deduct amounts over time that reflect the actual decline
can take many forms , including installing new lighting and
in their value, until the original cost has been recovered.
carpet in a leased office, adding new woodwork and
This decline in value is known as depreciation. Deductions
windows to the dining room of a restaurant, and painting
for depreciation usually are taken over three or more years.
the walls and upgrading the sound system of a retail store.
Depreciation based on the actual decline in the value of an
Before the enactment of the American Jobs Creation Act of
asset is known as economic depreciation. An advantage of
2004 (AJCA, P.L. 108-357), the cost of improvement
economic depreciation is that it fosters neutrality in an
property was generally recovered over 39 years using the
income tax’s impact on the returns to investment in a range
straight-line method under the ADS. This method requires
of depreciable assets. For several reasons (including a
businesses to deduct an equal amount of the acquisition cost
desire to simplify business tax accounting), many countries
of a depreciable asset every year until the initial cost has
employ systems for tax depreciation that deviate from
been recovered.
economic depreciation.
The AJCA established two categories of improvement
Depreciation of Tangible Assets under
property (“qualified leasehold improvement property,” or
Current Federal Tax Law
QLP, and “qualified restaurant improvement property,” or
There are two systems for depreciating tangible assets (e.g.,
QRP) and lowered their cost recovery period under the
nonresidential buildings, equipment, and software) under
MACRS to 15 years, making both kinds of improvement
current law: (1) the modified accelerated cost recovery
property eligible for the 50% bonus depreciation allowance
system, or MACRS (Section 168 of the federal tax code);
then available under Section 168(k). Consequently,
and (2) the alternative depreciation system, or ADS
nonresidential building owners or leaseholders could write
(Section 167 of the federal tax code). With its generally
off half the cost of new improvement property in the year it
shorter depreciation lives and accelerated depreciation
was placed in service and the remaining half over the
schedules, the MACRS allows firms to write off a larger
following 14 years with the straight-line method.
portion of an asset’s cost early in its recovery period.
Improvements to leasehold property qualified for the 15-
The MACRS contains two provisions that allow firms to
year cost recovery period if they (1) were made according
expense part or all of the cost of eligible assets. Section
to the terms of a lease by the lessee or the lessor; (2) were
179, which applies to machinery and equipment, computer
placed in service more than three years after the
software, and selected nonresidential real property, allows
nonresidential building was first placed in service; and (3)
companies to expense a limited amount of the cost of
did not enlarge the building, install or upgrade elevators and
qualified assets in the year when they are placed in service.
escalators, or alter its “internal structural framework.”
For the 2020 tax year, the allowance is capped at $1.04
million for a taxpayer, and it begins to phase out when a
Improvements to restaurant property qualified for the 15-
company’s total spending on qualified assets in 2020
year cost recovery period if they met two criteria. First, the
exceeds $2.59 million. Both amounts are indexed for
improvements had to be placed in service more than three
inflation.
years after the building was first placed in service. Second,
at least 50% of a building’s interior space had to be used for
Section 168(k), known as the bonus depreciation allowance,
food preparation and dining on the premises.
applies to tangible assets with a depreciation life of 20 years
or less under the MACRS. The current allowance covers
In 2008, Congress created a separate category of
100% of the cost of qualified assets placed in service
improvement property for retailers known as “qualified
between September 28, 2017, and December 31, 2022. It is
retail improvement property” (QRIP) in the Tax Extenders
scheduled to decrease to 80% of the cost of qualified assets
and Alternative Minimum Tax Relief Act of 2008 (Division
placed in service in 2023, 60% in 2024, 40% in 2025, 20%
C of P.L. 110-343). The act assigned a 15-year cost
in 2026, and 0% in 2027 and thereafter.
recovery period to QRIP placed in service in 2009 and
thereafter. Retail improvements qualified for this treatment
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Tax Depreciation of Qualified Improvement Property: Current Status and Legislative History
if (1) they represented an upgrade to the interior of a
specified that there was to be “a general 15-year MACRS
nonresidential building; (2) the building’s interior was open
recovery period for qualified improvement property.”
to the general public and used primarily for selling tangible
personal property to the general public; and (3) the
As a result, the cost of QIP had to be recovered over 39
improvement property was placed in service more than
years under the MACRS (or 40 years under the ADS). As
three years after the building was first placed in service.
39-year property, QIP was ineligible for the Section 168(k)
Like QLP and QRP, the cost of QRIP had to be recovered
100% expensing allowance that the 2017 tax revision
using the straight-line method of depreciation and was
established through 2022—although QIP did continue to
eligible for the expensing allowance under Section 168(k).
qualify for the Section 179 expensing allowance. Several
bills in the 115th and 116th Congresses would have rectified
The Protecting Americans from Tax Hikes Act of 2015
this unintended omission.
(P.L. 114-113) permanently extended the 15-year recovery
period for QLP, QRP, and QRIP. It also created a fourth
The Coronavirus Aid, Relief, and Economic Security
category of improvement property known as qualified
(CARES) Act (P.L. 116-136) corrected the omission by
improvement property (QIP). Improvement property
designating QIP as 15-year property under the MACRS and
qualified as QIP if it satisfied several criteria. First, the
20-year property under the ADS, if the qualified
property had to improve the interior of a nonresidential
improvement is done by the taxpayer. In both cases, cost
building without enlarging the building, upgrading or
recovery has to use the straight-line method. This
installing elevators or escalators, or modifying its internal
modification was made retroactive to January 1, 2018, the
structural framework. Second, the property had to be placed
date most of the changes made by the tax revision went into
in service after the building was placed in service, not three
effect. Business owners have several options for claiming
or more years afterward as was the case with QLP, QRP,
15-year treatment for QIP placed in service in 2018, 2019,
and QRIP. Third, the property could be placed in service
and 2020, including filing amended returns for 2018 and
without a lease. Cost recovery for QIP could take place
2019.
over 15 years or 39 years. The 15-year depreciation life
applied only if QIP also met the requirements for QLP,
Accelerated Depreciation and Investment in
QRP, or QRIP. Cost recovery for QIP had to be done with
Qualified Improvement Property
the straight-line method, and it qualified for the Section
The tax treatment of depreciation for QIP matters to owners
168(k) expensing allowance only if the property qualified
of commercial real estate and leaseholders because it can
for 15-year cost recovery.
affect the cost of capital. In theory, speeding up the
depreciation of QIP defers the payment of tax on the profits
The tax revision enacted in late 2017 (P.L. 115-97)
it earns. While faster depreciation does not alter the total
accelerated the depreciation of many tangible assets, but not
amount that can be deducted for the cost of QIP, it does
nonresidential buildings. Still, it did modify the
reduce the present value of taxes on the returns from
depreciation rules for improvement property by combining
investing in the asset. This reduction reflects the fact that a
the four categories of improvement property under previous
dollar received today is worth more than a dollar received
law into a single category called QIP and setting forth the
in a future year. Accelerating the tax depreciation of QIP
conditions that had to be satisfied if QIP was to be
lowers the pretax rate of return an investment in QIP has to
considered 15-year property. Those conditions were the
earn to achieve a targeted after-tax rate of return.
same conditions that defined QIP under previous law. This
change applied to tax years beginning in 2018 and

thereafter.

However, contrary to congressional intent, the act
inadvertently left QIP off the list of assets eligible for a 15-
Gary Guenther, Analyst in Public Finance
year cost recovery period under the MACRS. The
conference agreement for H.R. 1 (H.Rept. 115-466)
IF11187

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Tax Depreciation of Qualified Improvement Property: Current Status and Legislative History

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https://crsreports.congress.gov | IF11187 · VERSION 2 · UPDATED