New IRS Revenue Procedure Explains Bonus Depreciation for Qualified Improvement Property
The PATH Act (Protecting Americans from Tax Hikes) that passed at the end of 2015 included a new category of depreciable property eligible for bonus depreciation – qualified improvement property – but was short on details for taking advantage of this new category. The new revenue procedure 2017-33 provides guidance on several taxpayer-friendly depreciation provisions, including this new category of property.
Prior to 2017, the IRS published revenue regulations as a way to inform the public about its interpretations of new laws. However, like all other federal agencies, the IRS is currently prohibited from issuing new regulations, so as a stopgap measure, the IRS is, instead, issuing revenue procedures.
Qualified improvement property is defined in IRS Code Section 168(k)(3) as improvements to the interior of non-residential property. This class does not include enlargements, structural framework, elevators or escalators. These improvements must be placed in service after Jan. 1, 2016, and after the building is first placed in service.
For this revenue procedure, “first placed in service” means the first time the building is used by anyone for any purpose. This is a more generous definition than the IRS usually applies. More often, “first placed in service” must be the first time the current owner uses the property. But, for qualified improvement property, the first use of the building can be by a previous owner.
As examples in the revenue procedure indicate, the improvements can be placed in service as soon as one day, after the building is first placed in service. In one example, plans for an office building being constructed were modified to include an additional restroom. The additional restroom was placed in service exactly one day after the rest of the building, and thus qualified as qualified improvement property.
This new type of property is 39-year property, but unlike most 39-year property, it is eligible for bonus depreciation. For 2016 and 2017, the bonus amount is 50 percent, but it’s scheduled to phase out to 4 percent for 2018, then to 30 percent for 2019, before disappearing altogether in 2020.
Qualified improvement property differs from qualified leasehold improvement property, in that the improvements need not be made pursuant to a lease between non-related parties. This makes this new property class a great option for self-rentals. In addition, qualified leasehold improvement property must be placed in service at least three years after the building is first placed in service, unlike this new class, where the improvements can be placed in service as little as one day, after the building is placed in service.
This new class of property can be improvements that wouldn’t qualify as either qualified retail improvement property or qualified restaurant property. Qualified retail improvement property is restricted to the parts of a building that are accessible to the public for the sale of tangible goods. Qualified restaurant property requires that at least 50 percent of the square footage of the building be used for the preparation of food, and seating for the consumption of that food, on premises. Both of these types of property, like qualified leasehold improvement property, are depreciated over 15 years.
Unlike qualified leasehold improvement property, qualified retail improvement property and qualified restaurant property, this new category of real property is not eligible for section 179 expensing. But, because bonus depreciation is not subject to the income limitations of section 179 expensing, it can be used to create a loss.
Qualified restaurant property normally does not qualify for bonus depreciation. But, improvements to an existing restaurant that also meet the requirements for qualified improvement property will qualify for bonus depreciation.
We recently applied this to a client who bought an existing restaurant and made extensive improvements before reopening. The building, itself, met the definition of qualified restaurant property, and will be depreciated over 15 years. The new improvements are also qualified improvement property since the building was already in service by the previous owner. Due to income limitations, section 179 expensing was not a good strategy for this client, but taking bonus depreciation on the improvements resulted in a huge tax savings.