QIP vs. Restore Laws – Choices, Choices, Choices … – Business Observer

Has your company been hard hit by the COVID-19 pandemic? While the pandemic has badly affected the business of many companies, the good news is that much-needed help is now available to many. The Coronavirus Aid, Assistance and Economic Security Act (CARES) was incorporated into law on March 27, 2020 and offers extensive economic relief, including some significant changes to tax law. The new CARES Act provision on the tax treatment of Qualified Improvement Properties (QIP) is particularly noteworthy for taxpayers in the real estate, restaurant, retail and hospitality industries as these companies have been hard hit by the COVID-19 pandemic.

The CARES Act: Before the CARES Act came into force, QIP, which came into service after December 31, 2017, had to have a tax term of 39 years and was not entitled to bonus write-offs. The CARES law passed in 2020 changed the QIP retrospectively to a tax period of 15 years so that taxpayers can claim a 100% bonus write-off. The change is retroactive as of January 1, 2018. This is good news as property owners can now write off QIP over a shorter tax period of 15 years or write off 100% of the cost of the asset instantly using bonus write-offs.

What is Qualified Improvement Property (QIP)? QIP is an internal improvement on non-residential property after the property is first put into service by a taxpayer. The definition of QIP does not include expenses related to the expansion of a building, elevator or escalator, or the internal structural framework of a building. The CARES Act makes it clear that the improvement "must be made by the taxpayer". This means that a taxpayer may not buy real estate and not treat improvements previously made by the seller as a QIP.

Additional Considerations: While instant bonus depreciation may sound like a great tax saving strategy, it has downsides, as detailed below.

1. Depreciation recaptured: The bonus depreciation is subject to the reversal of the depreciation in the year of sale. If you are selling properties for which you have applied for a 100% Bonus Depreciation, any taxable gain up to the amount of the bonus depreciation will be treated as a higher taxed ordinary income rather than a lower long-term capital gains tax rate. Under the current federal income tax system, the ordinary income recorded by an individual taxpayer can be taxed at a tax rate that is almost twice, if not higher, the tax rate on investment income.

2. Status addback:: Another point to consider is the state income tax treatment of bonus write-offs. Most states do not allow bonus write-offs and require a state top-up equal to the bonus write-off specified in the federal tax return. Depending on the amount of the bonus write-off, the government addback could place you in a higher government tax bracket. Due to the interplay with the limitations of business interests, a real estate deal or business may wish to forego a bonus write-off on 15-year real estate in order to fully deduct the interest expense.

3. Bonus expire: The bonus depreciation is not permanent. According to current law, it can expire for properties commissioned in the calendar year 2023 and will be completely eliminated in 2027. For properties commissioned in 2023, 60%, 2024, 40%, 2025 and 20%, 2026, a rate of 80% applies and a rate of 0% applies to 2027 and later years.

Repair regulations analysis may be a better choice: If you are looking for a tax saving strategy that is similar to the immediate depreciation benefit of bonus depreciation, but you want to eliminate the negative effects of depreciation rollback and government backlash, You may want to consider an analysis of the repair regulations as an alternative.

Repair regulations analysis applies to companies in all industries that acquire, manufacture, replace, or improve tangible property. The process includes reviewing your depreciation plan to make sure that you have handled the past cost correctly.

Prior to the enactment of the repair regulations in 2014, every time a taxpayer purchased an asset with a useful life of more than a year, the taxpayer had to capitalize the cost of that asset and write it off over its taxable life. However, it was not made clear how to treat the cost of repairing an asset. For example, due to water leaking from the roof, you hired a contractor to replace 100% of your old roofing membrane with a brand new roofing membrane of similar quality. Are these costs that need to be capitalized or should they be deducted as repair costs? Due to the lack of guidance in this area, you may have activated it as conservative.

In 2014, Congress finally issued repair regulations that provide guidance on which costs must be capitalized and which costs can be deducted as repair costs. Surprisingly, it turns out that the cost of replacing the entire roofing membrane can be deducted as repair costs in accordance with the repair regulations and under the right circumstances.

Analyzing repair regulations could be an opportunity for huge tax savings, especially if you, as a lessor, make improvements to tenants. For example, a landlord owns a six-story commercial office building. A tenant occupying the second floor moved out in 2012 and a new tenant moved into this unit that same year. To prepare the unit for the new tenant, the landlord spent $ 2 million renovating the space. According to the old regulations, the landlord would have capitalized and written off the costs over 15 years. However, due to the repair regulations, these costs can now be deducted.

In this situation, the landlord can file a 3115 Form to formally pass regulations and charge the remaining base of $ 2 million in assets, which is a significant deduction this year. Additionally, we can apply the rules to any unamortized property base and potentially make large deductions in the current year.

Going back and reviewing depreciable assets could be a way to save taxes, but you don't necessarily have to go back to apply repair regulations analysis. You can also apply the repair regulations analysis to all future construction and repair work. However, if you have not formally adopted the regulations in the past, you will need to change your accounting method to formally adopt the regulations first.