Bonus Depreciation Changes and Introduction of Qualified Improvement Property

President Obama signed the Protecting Americans from Tax Hikes (PATH) Act of 2015 into law this past December. Two of its provisions included an extension of bonus depreciation through 2019 and made provisions for qualified leasehold improvements (QLI), qualified retail improvements (QRET), and qualified restaurant property (QRES) permanent. Along with the extension, the concept of qualified improvement property (QIP) was introduced.

Qualified improvement property replaces bonus deduction rules for qualified leasehold improvements starting in 2016. Qualified improvement property will now include 39-year property (no longer limiting bonus deductions to property with a 15 year life), which will provide taxpayers with more opportunities to deduct bonus depreciation. Qualified improvement property is limited to any improvement to an interior portion of a building which is nonresidential real property placed in service after the date the building was first placed in service. This definition differs from the previous qualified leasehold improvement rules, which required that the building be in service for three years before an owner or lessee was able to take advantage of the bonus depreciation deduction.

Currently, many taxpayers make the mistake of claiming bonus depreciation on all tenant improvements and leasehold costs, including roofing, concrete and windows, which should all be excluded since they are exterior improvements. Qualified improvement property also does not include costs for the enlargement of the building, elevators and escalators, or the internal structural framework of the building.

Although the new qualified improvement property rules work in the taxpayer’s favor, there are stipulations which decrease the amount of deductible bonus depreciation for qualifying assets placed in service. For assets placed in service in 2016 and through the end of 2017, taxpayers may continue to take 50% of the adjusted basis of the qualified property for the first year in service. The deduction is reduced to 40% for property placed in service in 2018, and to 30% for property placed in service in 2019. For self-constructed property, the date placed in service is crucial. Failure to complete the project by December 31, 2017 will cause the loss of 10% of the bonus depreciation.

With this new provision in place through 2019, taxpayers have the opportunity to plan ahead to take advantage of the higher deduction for the 2016 and 2017 tax years. Taxpayers may also maximize their bonus deductions, by considering a cost segregation study of the tax lives of assets and improvements, which may work in their favor to potentially reclassify 39-year live property to property with a 5, 7, or 15-year life.

Should you have any questions about how the new QIP classification may affect you or your business or how you may benefit from a cost classification study, contact your Marcum Tax Professional.