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Taxpayers get one shot at changing QIP depreciation

May 1, 2020

On April 17th, the IRS released Revenue Procedure 2020-25 to provide taxpayers guidance on implementing the changes to depreciation of qualified improvement property (QIP). As discussed in Waller’s prior blog post, the CARES Act provided a technical correction for the Tax Cuts and Jobs Act of 2017, which precluded QIP from receiving 100% bonus depreciation under even though it was previously eligible for 50% bonus depreciation. Now, QIP acquired after September 27, 2017 and placed in service after December 31, 2017 is eligible for 100% bonus depreciation as 15-year property, and otherwise can be depreciated over 15 years using the general depreciation system (GDS) or 20 years using the alternative depreciation system (ADS).

The Revenue Procedure provides various means for taxpayers to change the depreciation and allows taxpayers to retroactively make, revoke or withdraw (as if it was never made) an election, under Section 168(g)(7), (k)(5), (k)(7), or (k)(10) of the Code for the taxpayer’s 2018, 2019, or 2020 taxable years. An election under Section 168(g)(7) allows depreciation of any class of property under ADS; an election under Section 168(k)(5) allows bonus depreciation of certain property used in farming business; an election under Section 168(k)(7) allows bonus depreciation for any class of property that is qualified property placed in service during the taxable year; and an election under Section 168(k)(10) allows 50% bonus depreciation rather than 100% for qualified property acquired after September 27, 2017 and placed in service during the taxable year that includes September 28, 2017.

To change QIP depreciation or make another change permitted by Revenue Procedure 2020-25, taxpayers may file either:

  1. an amended tax return for the relevant taxable period,
  2. an administrative adjustment request under section 6227, or
  3. a Form 3115, Application for Change in Accounting Method or a change in accounting method to change the depreciation of QIP.

Note that the 2018 taxable year is defined as the taxable period ending in in 2018, which allows fiscal year taxpayers who may have a taxable year ending in January 2018 additional bonus depreciation.

Doing nothing is not an option. The Revenue Procedure provides that using a depreciation method that recovers the cost of QIP over 39 years or 40 years for 2018, 2019 or 2020 taxable years is an “impermissible method” for which an adjustment is made under Section 481 of the Code, although it was a permissible method at the time. The drafter of the Revenue Procedure, Kathleen Reed, the Income Tax & Accounting Branch Chief of the Office of Chief Counsel (IRS), clarified that taxpayers who have taken depreciated QIP over anything other than 15 years are required to retroactively change their position, stating during a webcast on April 27th that “once the President signed” the CARES Act it became impermissible to treat QIP as having a 39-year useful life.

Thus, every taxpayer needs to make a choice about how to correct their depreciation of QIP for property placed in service during its 2018, 2019, and/or 2020 taxable year, and taxpayers are permitted only one automatic change per taxable year under the Revenue Procedure. Taxpayers who are filing a Form 3115 are instructed to make changes to multiple assets concurrently on one Form 3115. Reed explained that, under the Revenue Procedure, one automatic change is allowed and thereafter a taxpayer can make a change via private letter ruling request, which will be reviewed based on the taxpayer’s facts and circumstances. Requesting a private letter ruling, however, is an expensive endeavor that most taxpayers will want to avoid.

Given that taxpayers have “one shot” under the Revenue Procedure, before making any such change, taxpayers should evaluate the past, present and future tax consequences. In particular:

  • Interaction with the 5-year carryback of net operating losses, the temporary waiver of the 80% limitation on the use of net operating losses, and the temporary increase in the amount of deductible business interest expense provided by the CARES Act;
  • Proper characterization of QIP⸺
    • QIP is non-structural interior improvements made to non-residential real property, such as retail store and office interior renovations.
    • Notably, QIP does not include enlargement of a building, improvement to the internal structural framework of a building, work on air conditioning units that are located outside of a building, escalators and elevators, and fixtures such a “sneeze-guards” put in service during COVID-19 that can be easily removed.
  • A taxpayer who has QIP made by a third-parties should look to forthcoming guidance from the IRS. In the April 27 webcast, Reed provided that this is the only outstanding substantive issue. She indicated that taxpayers should expect final regulations this summer that will address this issue.

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