Correcting the Retail Glitch – Depreciation Fix for Qualified Improvement Property in Coronavirus Relief Law
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The CARES Act (Pub. L. No. 116-136), enacted on March 27, 2020, provides emergency assistance and addresses health care concerns of individuals, families, and businesses affected by the 2020 coronavirus pandemic. Section 2307 contains a technical correction to a drafting error in the 2017 Tax Cuts and Jobs Act (TCJA) known as the “retail glitch.”
How does the CARES Act affect bonus depreciation?
The correction effectively allows businesses to claim 100% bonus depreciation on qualified improvement property placed in service after 2017 provided all other requirements are met, which was not previously possible because of the error. For example, the acquisition requirements must be met; the QIP must not be held by an electing real property trade or business or an electing farming business; and the QIP must not be tax-exempt use property or outside the United States, etc. The technical correction may impact depreciation deductions claimed by taxpayers on prior year tax returns.
Taxpayers should consider amending prior year returns to claim bonus depreciation for QIP placed in service in 2018, or filing an automatic Form 3115, Application for Change in Accounting Method, with the 2019 return to take advantage of the new favorable treatment and claim the missed depreciation as a favorable IRC section 481(a) adjustment.
What is the “retail glitch”?
For property placed in service after December 31, 2017, the 2017 TCJA eliminated the 15-year MACRS property classification for qualified leasehold improvement property, qualified restaurant property, and qualified retail improvement property, and replaced them with a single classification: qualified improvement property (QIP).
In general, QIP means any improvement to an interior portion of nonresidential real property. Expenses attributable to the enlargement of a building, elevators or escalators, or changes to the internal structural framework of a building are excluded from this definition.
The legislative history of the TCJA clearly indicates that lawmakers intended to assign QIP a recovery period of 20 years or less to make it eligible for the new 100% bonus depreciation rate.
However, the final legislative text failed to do so. Because of this drafting oversight, before the technical correction, taxpayers were required to depreciate QIP using a 39-year recovery period for QIP, making it ineligible for bonus depreciation.
How can businesses take advantage?
As communities enforce social distancing to combat the spread of the coronavirus, many businesses, especially those in the hospitality, restaurant, and retail industries, are experiencing negative economic consequences as a result. However, many companies, in particular those in the aforementioned industries, should see meaningful relief from the CARES Act.
The ability to immediately deduct costs associated with improving facilities instead of having to depreciate those improvements over 39 years not only increases businesses’ access to cash flow, but also incentivizes them to continue to invest in their facilities.
Companies that meet the following criteria should immediately consider amending prior year filings if:
- QIP was placed in service by Company after December 31, 2017;
- Company filed a tax return with QIP and depreciated it over 39 years with no bonus depreciation;*
- Company paid tax (i.e., had taxable income) on said tax return; and
- Company has a need for cash today.
*If two tax returns have been filed using the 39-year life for a given asset, the only way to “fix” the retail glitch would be through filing Form 3115, Application for a Change in Accounting Method. This defers the adjustment to the tax year for which the Form 3115 is filed.
Companies must weigh the option to fix the retail glitch through an amended return against filing a Form 3115 to change its accounting method. If the company has or is expecting a taxable loss in 2019 or 2020, a favorable Section 481(a) adjustment (i.e., reduction to taxable income) may create or add to such loss.
As part of the CARES Act legislation, the 80%-of-taxable-income limitation is eliminated for losses arising in tax years beginning in 2018, 2019, or 2020, and such losses are permitted to be carried back to the five preceding taxable years. Corporate taxpayers may be able to carry back that loss to a tax year when the corporate federal income tax rate was 35%, creating a permanent tax savings because of the rate differential.
Lastly, with many businesses – particularly retail and restaurant establishments – shuttered across the country, now may be a good time to consider investing in further necessary improvements. Those improvements, assuming they are also QIP, would likewise qualify for 100% bonus depreciation.