April 21, 2020
IRS and Treasury release favorable, broad procedural guidance for implementing CARES Act provisions on qualified improvement property and certain elections
Revenue Procedure 2020-25 provides important procedural rules specific to the implementation of the Coronavirus Aid, Relief, and Economic Security (CARES) Act provisions for qualified improvement property (QIP). The procedure also provides specific guidance on the use and revocation or withdrawal of certain bonus depreciation and alternative depreciation system (ADS) elections.
The revenue procedure, in general, provides the authority for taxpayers to file Forms 3115 or, alternatively, amend tax returns to reflect the retroactive, technical amendments made by the CARES Act. The CARES Act changed the recovery period for QIP to 15 years, which also made QIP eligible for 100% bonus expensing under the general depreciation system (GDS). The recovery period is 20 years for ADS property, which is generally not bonus eligible.
This Tax Alert discusses key federal tax provisions and implications of the new guidance. For further details regarding the various provisions of the CARES Act, see other Tax Alerts, including Tax Alerts 2020-0708 and 2020-0806, as well as a recent Alert related to NOL guidance (Tax Alert 2020-0969).
When the Tax Cuts and Jobs Act (TCJA) eliminated the separate definitions of qualified leasehold improvement property, qualified restaurant property and qualified retail improvement property and provided for a single definition for QIP under IRC Section 168(e)(6), we understand that Congress intended to provide a 15-year recovery period for QIP placed in service after December 31, 2017. Due to an apparent oversight, however, IRC Section 168(e)(3)(E), the provision generally describing the property to which a 15-year recovery period applies, was not amended to include QIP. As a result, QIP acquired after September 27, 2017, and placed in service after December 31, 2017, was treated as nonresidential real property recovered over 39 years and, accordingly, was not eligible for bonus depreciation. Note that QIP acquired after September 27, 2017, and placed in service on or before December 31, 2017, was eligible for bonus depreciation prior to changes made by the CARES Act and is not addressed in the revenue procedure.
The TCJA also extended the bonus depreciation deduction through 2026 generally. The TCJA allows taxpayers to claim 100% bonus depreciation for qualified property acquired and placed in service after September 27, 2017, and before January 1, 2023, phasing down bonus depreciation as follows:
(Special rules apply for long production period property and certain noncommercial aircraft under IRC Section 168(k)(2).)
The TCJA specifies that qualified property for purposes of bonus depreciation includes tangible property with a recovery period of 20 years or less under MACRS, provided the remaining requirements of IRC Section 168(k)(2) are met. The TCJA, however, removed the specific reference to QIP as being qualified property, so under the TCJA QIP was not eligible for bonus depreciation (because it is effectively treated as nonresidential real property with a 39-year recovery period per the discussion above).
The CARES Act amends IRC Section 168(e)(3)(E) to retroactively include QIP as property to which a 15-year recovery period applies and for which bonus depreciation may be claimed. Because of the new technical amendments, taxpayers that make or have made improvements meeting the definition of QIP may now take appropriate steps to correct recovery periods consistent with the CARES Act revisions (and, accordingly, claim the missed 100% bonus depreciation when applicable).
As specified in the CARES Act, QIP includes "any improvement, made by the taxpayer, to an interior portion of a building that is nonresidential real property, if that improvement is placed in service after the date the building was first placed in service." IRC Section 168(e)(6)(B) excludes from QIP any improvement for which the expenditure is attributable to: (i) the enlargement of the building, (ii) any elevator or escalator, or (iii) the internal structural framework of the building. If a taxpayer elects out of bonus depreciation, such property is depreciated under the GDS using the straight-line method of depreciation, a 15-year recovery period, and the half-year or mid-quarter convention, as applicable, under IRC Sections 168(b)(3), (c), and (d). Further, such property is depreciated under the ADS using the straight-line method of depreciation, a 20-year recovery period, and the half-year or mid-quarter convention, as applicable, under IRC Sections 168(g)(2) and (3)(B).
A flowchart is attached to this Tax Alert as a summary guide to navigating the QIP requirements.
Revenue Procedure 2020-25
Revenue Procedure 2020-25 applies to QIP placed in service after December 31, 2017, in the taxpayer's 2018, 2019 or 2020 tax year. It does not apply to QIP placed in service after December 31, 2017, by a taxpayer that made a late election or withdrew an election under IRC Section 163(j)(7)(B) or 163(j)(7)(C) for the tax year in which the QIP is placed in service by the taxpayer (electing real property trades or businesses or electing farming businesses). (For electing real property trades or businesses, see Revenue Procedure 2020-22 for making or revoking the election under IRC Section 163(j) and corresponding modifications to depreciation, including QIP.) Revenue Procedure 2020-25 also does not apply to QIP for which the taxpayer deducted or deducts cost or other basis of the QIP as an expense.
QIP and certain cost recovery elections
Revenue Procedure 2020-25 generally permits a taxpayer to file an automatic Form 3115 in its 2018, 2019 or 2020 tax year (with such years further defined under the procedure) to change the depreciation of QIP placed in service after December 31, 2017. Further, the procedure permits a taxpayer to make a late election out of bonus depreciation or revoke an election out of bonus depreciation (in addition to making other identified elections, such as a late ADS election) with respect to all or any class of property placed into service within the 2018, 2019, or 2020 tax year. New automatic method changes related to these provisions are identified further below.
Revenue Procedure 2020-25 alternatively allows taxpayers to change the depreciation for QIP placed in service after December 31, 2017, by filing an amended income tax return or amended Form 1065 for the placed-in-service year of the QIP on or before October 15, 2021. In any case, the amended return or amended Form 1065 may not be filed later than the applicable period of limitations on assessment for the tax year for which the amended return is being filed. A partnership subject to the Bipartisan Budget Act of 2015 that chooses not to file an amended Form 1065 or cannot file the amended Form 1065 because the QIP's placed-in-service year is a tax year that is not within the scope of Revenue Procedure 2020-23 may file an administrative adjustment request (AAR) before October 15, 2021. These amended return/AAR procedures are also in place for taxpayers to utilize as an alternative to the filing of a method change as detailed above in order to make a late election out of bonus depreciation or revoke an election out of bonus depreciation (in addition to making other identified elections, such as a late ADS election).
New automatic changes
Revenue Procedure 2020-25 modifies Revenue Procedure 2019-43 to add two new automatic method changes for changing the depreciation of QIP placed in service after December 31, 2017, and making late elections under IRC Sections 168(g)(7), (k)(5), (k)(7) and (k)(10) or revocations under IRC Sections 168(k)(5), (k)(7) and (k)(10). Specifically, the added changes are:
The modifications to the cost recovery of QIP, coupled with various additional provisions of the CARES Act and various recent guidance (e.g., Revenue Procedure 2020-22 and Revenue Procedure 2020-23), provide taxpayers with a significant opportunity to reevaluate their current and prior tax positions and implement various cash tax planning strategies. As a part of this analysis, Revenue Procedure 2020-25 provides tremendous flexibility for taxpayers to reevaluate their current depreciation methods and elections in light of the current economic climate. Affected taxpayers will need to carefully consider the interaction of various amended Code provisions (e.g., the interaction between the provisions of IRC Section 163(j) and IRC Section 168, as both have been modified by the CARES Act). Taxpayers also may need to engage in financial modelling to determine the best use of available deductions as well as, when applicable, various tax attributes such as NOLs during the limited periods in which these taxpayer-favorable changes are in place. In addition, taxpayers should evaluate restructuring opportunities that may permit them greater utilization of certain tax attributes.
QIP Determination Chart