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Long Awaited “Retail Glitch” Technical Correction

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The Tax Cuts and Jobs Act (“TCJA”) expanded the bonus depreciation provision in I.R.C. Section 168(k) from fifty (50%) percent to one hundred (100%) percent.  Unfortunately, Congress failed to assign qualified improvement property a fifteen (15) year recovery period when drafting the TCJA, rendering qualified improvement property ineligible for bonus deprecation.  Since the TCJA was enacted, taxpayers, especially those in the retail and restaurant industries, have been waiting for a technical correction to fix this oversight error commonly known as the “retail glitch”.  The Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”) finally offers that technical correction.  The CARES Act makes two significant changes to I.R.C. Section 168 regarding qualified improvement property.  First, qualified improvement property is assigned a fifteen (15) year recovery period making it eligible for bonus depreciation and is assigned a twenty (20) year recovery period for the alternative depreciation system (“ADS”).  Second, the definition of qualified improvement property was modified to include only improvements made by the taxpayer.  These changes are effective retroactively to 2018 (i.e., effective with the passage of the TCJA).

Qualified improvement property is defined as any improvement to an interior portion of a building which is nonresidential real property if such improvement is placed in service after the date the building was first placed in service. Qualified improvement property does not include expenditures attributable to: (i) enlargement of the building; (ii) any elevator or escalator; or (iii) the internal structural framework of the building.

Now that qualified improvement property is eligible for bonus depreciation effective retroactively to 2018, how should taxpayers claim this benefit.

Partnerships

Under Rev. Proc. 2020-23 (issued April 8, 2020), partnerships subject to the centralized partnership audit rules are now permitted to amend their 2018 and 2019 returns and catch up bonus depreciation.

 

2018 Federal Income Tax Returns

Taxpayers who constructed qualified improvement property in 2018 and treated it as bonus ineligible property should consider amending their 2018 federal tax return.  For C corporations, claiming bonus depreciation on an amended return may generate net operating losses (“NOL”) that under the CARES Act can now be carried back five (5) years and can fully offset income.  Given the TCJA’s change in corporate tax rate to twenty-one (21%), carrying back 2018 NOLs to earlier tax years allows taxpayers to offset income subject to the thirty-five (35%) percent corporate tax rate.  This offset allows taxpayers to maximize their cash refund to receive immediate cash.

 

2019 Federal Income Tax Return

Instead of amending the taxpayer’s 2018 federal income tax return, the taxpayer may file an automatic Form 3115, Application for Change in Accounting Method, with the taxpayer’s 2019 federal income tax return.  By filing a Form 3115, the taxpayer can take advantage of the new favorable qualified improvement property bonus depreciation deduction and claim the missed depreciation as a favorable I.R.C. Section 481(a) adjustment.

If a taxpayer constructed qualified improvement property in 2019, and given the revised July 15, 2020 initial filing deadline, the taxpayer has not filed the taxpayer’s 2019 federal income tax return, then the taxpayer has additional time to determine the assets eligible for bonus depreciation.  The taxpayer may also consider filing an extension in order to properly claim the taxpayer’s bonus depreciation on the taxpayer’s 2019 federal tax return.

If the taxpayer has filed a 2019 federal income tax return treating qualified improvement property constructed in 2019 as bonus ineligible property, then the taxpayer may file a superseding 2019 return prior to the due date (including extensions) and claim bonus depreciation.

Real Property Trade or Business Taxpayer

If the taxpayer is in a real property trade or business and has elected out of the I.R.C. Section 163(j) business interest deduction limitation, then such taxpayer is unable to claim bonus depreciation on qualified improvement property.  The election is irrevocable once made.  Unless Congress changes the statute, the taxpayer cannot undo the election.  That being said, the taxpayer will benefit from a shorter twenty (20) year ADS life for qualified improvement property under the CARES Act.

 

With the CARES Act enactment, we anticipate the Treasury and the IRS will issue procedures in the months ahead to streamline the process and help taxpayers take advantage of these new rules.

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