CARES Act Provides Tax Benefits for Real Estate Investors: Fix for Qualified Improvement Property and Changes to Net Operating Loss Rules
– By –
Alexander Bagne, JD, CPA, MBA, CCSP – ICS Tax, LLC
Greg Bryant, CCSP – Bedford Cost Segregation, LLC
Curt Gautreau, CPA, CCSP – Cost Segregation Initiatives, LLC
Kevin Johnson, CCSP, LEED AP – ICS Tax, LLC
Malik Javed, CCSP – KBKG, Inc.
The 2017 Tax Cuts and Jobs Act (TCJA) consolidated three asset categories (Qualified Leasehold Improvement Property, Qualified Retail Improvement Property and Qualified Restaurant Property) into just one, Qualified Improvement Property (QIP) category. Our legislators intended to make QIP eligible for a 15-year recovery period which would have allowed for bonus depreciation treatment. Due to a drafting error, a recovery period was not assigned to QIP and therefore it defaulted to a 39-year recovery period for the General Depreciation System (GDS) and a 40-year recovery period for the Alternative Depreciation System (ADS). The CARES Act made the following two changes:
- Retroactively corrects the depreciable life of QIP reducing it from 39 to 15 years and therefore making QIP eligible for bonus depreciation.
- The definition of QIP was changed by adding language indicating the improvement must be made by the taxpayer.
QIP is defined as any improvement made by the taxpayer to an interior portion of a building that is nonresidential real property as long as that improvement is placed in service after the building was first placed in service by any taxpayer. However, improvements do not qualify if they are attributable to:
- the enlargement of the building,
- any elevator or escalator or
- the internal structural framework of the building.
Note: QIP applies only to nonresidential buildings, so owners of apartment buildings, assisted living facilities, and other types of residential rental properties must continue to depreciate interior real property improvements over 27.5 years.
Tax Tip: The value of a cost segregation study for remodeling projects could substantially increase, as many expenditures depreciated as 39-year property prior to CARES are now eligible for 100% bonus depreciation. Taxpayers who elect out of the interest limitations under 163(j), are required to use a 20-year ADS life for QIP and therefore are not eligible for bonus depreciation. In these cases, a cost segregation study is greatly beneficial because the items segregated into personal property categories do not get ADS treatment and are therefore eligible for bonus depreciation.
Rev. Proc. 2020-25 provides guidance allowing a taxpayer to change its depreciation for certain QIP placed in service after December 31, 2017, in tax years beginning in 2018, 2019, or 2020. The Revenue Procedure also describes how taxpayers can make a late election, or revoke or withdraw an election. Certain taxpayers are permitted to file an amended return, Administrative Adjustment Request (AAR), or file a Form 3115, Application for Change in Accounting Method to change their depreciation of QIP placed in service after December 31, 2017 in their 2018, 2019, or 2020 tax year. If a taxpayer chooses to file Form 3115, the applicable Designated Change Number (DCN) is 244, which is a change from an impermissible to permissible method and as a new DCN, does not have the 5-year scope limitations.
Tax Tip: Some taxpayers cannot immediately use all the deductions generated from a cost segregation study in the current tax year. In this situation, it may be advisable to take 100% bonus depreciation on QIP whereas elect out of bonus depreciation on 5 and 7-year assets. This may help keep the taxpayer in the lower tier of tax rates for many years to come.
Changes to the Net Operating Loss Rules
Prior to 2018, net operating losses (NOLs) could be carried back two years and forward 20, and when carried forward, they could offset 100% of taxable income. The TCJA altered these rules, disallowing all carrybacks related to post-2017 losses, providing for an indefinite carryforward period, and limiting the use of post-2017 losses when carried forward to 80% of taxable income.
For businesses expecting a loss for 2020, our legislators temporarily reversed the TCJA changes:
- Losses from 2018, 2019 and 2020, will be permitted to be carried back for up to five years. As was previously the case, a taxpayer will be permitted to forgo the carryback, and instead carry the loss forward.
- Losses carried to 2019 and 2020 will be permitted to offset 100% of taxable income, as opposed to 80% enacted under the TCJA.
Tax Tip: The value of performing a comprehensive fixed asset review, cost segregation study, and §179D Energy Efficient Commercial Building Deduction study, especially since QIP can be immediately deducted, could generate sizeable losses that would allow taxpayers to recoup taxes paid up to 5 years ago.
To find the top cost segregation professionals near you, please visit https://ascsp.org/member-directory/#!directory/map.