Tax Considerations for Real Estate Investors under the CARES Act
Back in 2017, the additional first-year bonus depreciation deduction was increased from 50% to 100% for certain qualified property, as a result of the Tax Cuts and Jobs Act (TCJA). Also eliminated was the prior definitions for qualified leasehold improvement property, qualified restaurant property, and qualified retail improvement property into a category called qualified improvement property (QIP). Under the TCJA, the type of property that qualifies as QIP was expanded to include roofs, HVAC property, fire-protection and alarm systems, and security systems. It also treats both leased and owned improved space as QIP. The intention was that QIP would be eligible for a 15-year life; however, due to accidental oversight by Congress, the 15-year recovery period was not reflected in the statutory text of the TCJA. Thus, QIP was treated as 39-year life property effective January 1, 2018 and ineligible for 100% bonus depreciation.
After more than two years, this error has been repaired with a technical correction included in the Coronavirus Aid, Relief, and Economic Security (CARES) Act. Below, we outline the correction and explain the possible routes taxpayers can take to apply this change to their tax returns.
The CARES Act Amendment
The CARES Act implemented a long-awaited change, treating QIP as 15-year property and thus qualifying it for 100% bonus depreciation. The CARES Act also applies a 20-year life to QIP depreciated under the Alternative Depreciation System (ADS), and it amends the definition of QIP to include the clause that a qualified improvements must be “made by the taxpayer.” This new change is retroactive and applies to all QIP put into service after December 31, 2017.
The IRS released Rev. Proc. 2020-25 on April 17, 2020 to explain the options taxpayers have for taking bonus depreciation on QIP retroactively for tax years after December 31, 2017. Three options are available for taxpayers:
- They can file an amended return
- They can file Form 3115, Application for Change in Accounting Method
- They can file an Administrative Adjustment Request under Section 6227 to change their depreciation of QIP for tax years 2018, 2019 or 2020.
Taxpayers should consult their tax advisor to determine which method and tax year would be most beneficial to make the retroactive change. Less relevant, but still an interesting change included in this Rev. Proc. is that revocations and late filings related to bonus depreciation elections are allowed for a limited time for property placed in service by the taxpayer during their 2018, 2019, or 2020 tax years. These late elections or revocations are also allowed to be treated as changes in accounting methods with a Section 481(a) adjustment during this limited period.
The depreciation related changes provided in the CARES Act can be beneficial to real estate businesses. There is not only the potential for current tax savings but also large and unexpected tax refund windfalls due to the retroactive application of the law change. Please contact your Sikich tax expert to discuss how your business can benefit from this new CARES Act tax provision.