Many will remember the extreme overreaction that Congress undertook with the 1986 Tax Act. ACRS was replaced with MACRS and, in short order, depreciable lives went from 19 years to 31 years (then 39 years) for commercial property. The gross inequity of this Congressional fiat could be seen in the requirement that leasehold improvements be recovered over 39 years, even though that life bore no rational relationship to the life of the improvements.
In the 2008-2011 “Great Recession,” Congress began to correct some of the inequities that came in the extension of lives in the 1980s. Ever so slowly, these corrections have taken hold, proving to have strong constituencies and garnering more attention in the most recent tax act.
15-YEAR LIFE PERMANENT FOR CERTAIN ASSETS
Under The Protecting Americans from Tax Hikes (PATH) Act of 2015, a 15-year recovery period was made permanent for a few “special” categories of real property:
- Qualified Leasehold Improvements (QLI)
- Qualified Restaurant Property
- Qualified Retail Property
Since the general recovery period remains 39 years for most commercial real property (except land improvements and some very narrow industry-specific properties like single-purpose agricultural structures), these “carve outs” lessened the hit that landlords and tenants were taking when they were forced to recover these assets over the ludicrous 39-year life.
In addition to a 15-year life, the QLI and Qualified Retail Property categories qualify for bonus depreciation. Recently, bonus depreciation allowed 50% of the cost of a new asset to be expensed immediately. This provision has since expired, but PATH extended the period for bonus depreciation (just for QLI and Qualified Retail Property). Bonus depreciation itself will now be phased out completely by 2020 . . . or, perhaps, until the next election cycle. Perhaps most importantly for our readers, these “qualified” categories of property qualify for the full §179 deduction. For years, the real estate industry has been ignored in its pleas for an equitable extension of §179 to real property assets. PATH is a start toward putting the real estate industry on equal footing for the §179 deduction—at least for these limited categories.
BONUS DEPRECIATION EXPANDED
In addition to making these favorable categories permanent, a PATH provision that has a broad impact is a new category of building improvements: Qualified Improvement Property (QIP).
QIP is defined as any improvement to nonresidential interior space as long as that improvement is placed in service after the building was first placed in service. The QIP provisions are effective for property placed in service after December 31, 2015. Similar to Qualified Leasehold Improvements, QIP specifically excludes expenditures for: (1) the enlargement of a building; (2) elevators or escalators; and (3) the internal structural framework of a building. Although Qualified Improvement Property is depreciated over a 39-year recovery period, it was specifically identified as eligible for bonus depreciation.
The QIP definition is similar to that of Qualified Leasehold Improvements; however, there are subtle but distinct differences to note. For one, Qualified Improvement Property does require that the building have been placed in service at least three years prior to the expenditure. Further, QIP is not restricted to expenditures pursuant to a lease between non-related parties.
Interior components such as common area improvements in an owner-occupied building, or tenant improvements in a building less than three-years-old may be eligible for bonus depreciation as QIP even though they have 39-year recovery periods.