As part of the Protecting Americans From Tax Hikes (PATH) Act of 2015, P.L. 114-113, Division Q, Congress made a notable change to the definition of qualifying property for bonus depreciation purposes that received little attention, overshadowed by the fanfare given to the extension of bonus depreciation through 2019 (through 2020 for certain longer-lived and transportation property). Applicable to improvements placed in service starting in 2016, Congress created "qualified improvement property," a class of nonresidential real property now eligible for bonus depreciation irrespective of its recovery period. Taxpayers will have to determine separately if real property improvements are eligible for bonus depreciation and what their applicable recovery period is (generally 15 or 39 years for nonresidential real property). To be clear, not all nonresidential real property is eligible to be classified as qualified improvement property for bonus depreciation purposes.
As is well known, the PATH Act extended bonus depreciation through 2019 for property other than certain longer-lived and transportation property and introduced a gradual reduction from 50% in 2015 through 2017, to 40% in 2018, and to 30% in 2019, followed by its expiration after 2019.
Before the PATH Act, qualified property for bonus depreciation under Sec. 168(k)(2) consisted of modified accelerated cost recovery system property (1) with a recovery period of 20 years or less; (2) computer software as defined in, and depreciated under, Sec. 167(f)(1); (3) water utility property as defined in Sec. 168(e)(5); or (4) qualified leasehold improvement property. The PATH Act made changes to the definition of qualified property in Sec. 168(k)(2), removing qualified leasehold improvements from the definition and replacing that category with qualified improvement property. Under the requirements for qualified improvement property, unlike those for qualified leasehold improvement property, the improvement does not have to be made pursuant to a lease and does not have to be made to a building more than 3 years old. Note, however, that these requirements still apply for identifying qualified leasehold improvements under Sec. 168(e)(6).
Property eligible for bonus depreciation also must be original-use property, placed in service in the applicable time frame, and qualified property under Sec. 168(k)(2), as discussed below. Additional criteria also must be satisfied for noncommercial aircraft and long-term production property.
Effective for property placed in service after 2015, qualified improvement property is defined in Sec. 168(k)(3) as improvements to the interior of any nonresidential real property placed in service after the date the building was first placed in service. Qualified improvement property does not include expenditures to enlarge a building, for any elevator or escalator, or for the internal structural framework of the building. Further, qualified improvement property must be placed in service after the original building was placed in service. Contrast this change with the qualified leasehold improvement requirement that an improvement be placed in service at least three years after the building was originally placed in service. In 2016 through 2019, taxpayers should consider bonus depreciation eligibility and depreciation recovery period classification as a two-step process when selecting depreciation methods for nonresidential real property:
Step 1: Determine if the assets are depreciated over 39 years as nonresidential real property or over 15 years as qualified leasehold improvement, qualified restaurant, or qualified retail improvement property.
Step 2: Determine if the real property improvement assets are eligible for bonus depreciation as qualified improvement property.
Consider the following:
Example: A building is constructed and placed in service in 2015. In 2016, a tenant moves into the building and makes qualifying improvements to the interior of the building (i.e., not internal structural framework, escalator, or elevator). These improvements are not qualified leasehold improvements depreciable over 15 years under Sec. 168(e)(6) because the building is not at least 3 years old. The improvements are therefore depreciable over 39 years as nonresidential real property. However, these improvements are qualified improvement property placed in service after the building was placed in service, qualifying for 50% bonus depreciation in 2016 when placed in service, assuming all other requirements for claiming bonus depreciation are met. In addition, if the building's owner in 2016 makes qualifying improvements to the interior of the building (i.e., not structural framework, elevators, or escalators), these improvements also are not qualified leasehold improvements (because the building is not at least 3 years old), are depreciated over 39 years, and qualify for bonus depreciation. In each of these examples of qualifying improvement property, the improvements will also qualify for bonus depreciation if constructed and placed in service in 2017, 2018, or 2019.
However, note that in the example above, if the tenant or building owner removed load-bearing walls, added other structural framework, expanded the building, or completely replaced the entire roof structure and all HVAC units, these improvements would not meet the definition of qualified improvement property eligible for bonus depreciation, because they were expansions, made to the internal structural framework, or were not made to the interior of the building.
The expanded definition of bonus depreciation applicable to qualifying improvement property allows taxpayers to claim bonus depreciation starting in 2016 where bonus depreciation was previously limited to qualified leasehold improvements requiring the building to be at least 3 years old and the improvements to be made subject to a lease. The expanded definition of qualifying property allows bonus depreciation where not previously available for 39-year nonresidential real property, as long as the property was placed in service after the building was originally placed in service; it is original-use property; it is placed in service in the applicable time frame; and it is not an expansion, elevator or escalator, or improvement made to the internal structural framework.
Other notable changes to bonus depreciation rules made by the PATH Act include (1) allowing farmers to claim a 50% deduction (phased down after 2017) in place of bonus depreciation on certain trees, vines, and plants in the year of planting or grafting rather than the placed-in-service year, effective for specified plants planted or grafted after 2015 but before 2020, (2) adjusting the amount of bonus depreciation for automobiles, (3) extending long-term accounting method relief for bonus depreciation claimed on property placed in service in 2015 through 2019, and (4) striking outdated rules for property placed in service before 2008.
Kevin Anderson is a partner, National Tax Office, with BDO USA LLP in Washington.
For additional information about these items, contact Mr. Anderson at 202-644-5413 or firstname.lastname@example.org.
Unless otherwise noted, contributors are members of or associated with BDO USA LLP.