The IRS has released guidance (Rev. Proc. 2020-25) for correcting the recovery period for certain qualified improvement property (QIP), and making or revoking certain bonus depreciation elections in response to COVID-19 and changes enacted by the Coronavirus Aid, Relief, and Economic Security (CARES) Act.
The guidance is a welcome development for taxpayers who have placed QIP into service after Dec. 31, 2017, allowing them to take advantage of the technical correction made by the CARES Act to a drafting error in the Tax Cuts and Jobs Act (TCJA) commonly known as the “retail glitch.” Additionally, the guidance clarifies that taxpayers using the remodel-refresh safe harbor may generally treat the capital expenditure portion of the safe harbor as QIP instead of nonresidential real property.
The revenue procedure also includes procedures for either making a late election or revoking certain bonus depreciation elections and alternative depreciation system (ADS) elections previously made for a taxpayer’s taxable year ending in 2018, 2019 or 2020. This provides a great opportunity for taxpayers that wish to reassess their filing positions in light of the CARES Act.
Qualified improvement property
The Protecting Americans from Tax Hikes (PATH) Act first provided the definition of QIP that may apply to assets placed in service after Dec. 31, 2015. Qualified improvement property includes improvements made by the taxpayer to the interior portion of nonresidential real property that are placed in service after the building was first placed in service, but does not include structural components, elevators or escalators.
Qualified improvement property that is placed in service after Dec. 31, 2017, was intended to have a 15-year recovery period under the general depreciation system (GDS) or a 20-year recovery period under ADS, and generally be eligible for bonus depreciation. However, a drafting error in the TCJA left QIP off the list of 15-year property and made it ineligible for bonus depreciation. The CARES Act fixes that error and provides the originally intended 15-year GDS recovery period (20-year ADS) and bonus depreciation eligibility for QIP.
This guidance specifies that depreciating QIP as nonresidential real property is not permissible and provides the corrective actions of which a taxpayer may avail for its taxable years ending in 2018, 2019 or 2020. A taxpayer may generally correct its QIP by either: (1) filing an amended federal income tax return, amended Form 1065 or administrative adjustment request (AAR), as applicable, for the taxable year in which the property was originally placed in service on or before Oct. 15, 2021 (but not after the applicable period of limitations on assessment), or (2) attaching a Form 3115 to a timely filed federal income tax return. A partnership subject to the audit regime in the Bipartisan Budget Act (BBA) may want to file an amended return for its 2018 or 2019 taxable year on or before Sept. 30, 2020, pursuant to Rev. Proc. 2020-23.
According to Rev. Proc. 2020-25, an amended return or AAR must include the adjustment to taxable income for the QIP correction and any collateral adjustments to taxable income or tax liability. If returns have been filed for years subsequent to the year that is being amended, such years must also be amended for all collateral adjustments to taxable income or tax liability, which overrides the normal rule that prohibits changing an established method on amended return.
The procedure modifies the current list of automatic method changes in Rev. Proc. 2019-43 by adding a new change in Section 6.19 to be used for correcting QIP placed in service after Dec. 31, 2017. This change can be filed concurrently on the same Form 3115 with other impermissible to permissible depreciation changes, as well as certain bonus election changes filed under the new procedures described below.
Grant Thornton Insight:
The procedures are welcome guidance for taxpayers that have QIP affected by the CARES Act. Taxpayers have the opportunity to evaluate the varying impact of amending returns versus filing a Form 3115. In making the decision, they should consider the time it takes to implement the relief, particularly because of the volume of amended returns or AARs, potentially for more than one tax year.
Taxpayers that are either revoking or making late elections under Section 163(j)(7) are not permitted to use this revenue procedure to make such changes. Instead, they must follow the amended return procedures in Rev. Proc. 2020-22, which requires that all collateral adjustments, including depreciation changes and corrections, are to be made in accordance with that guidance. For more details on Rev. Proc. 2020-22, see our story, “IRS issues guidance for Section 163(j) elections.”
The guidance modifies Rev. Proc. 2015-56 to provide that taxpayers using the remodel-refresh safe harbor may treat the capital expenditure portion of the property included in that safe harbor calculation as QIP, to the extent that the taxpayer can substantiate that it meets the QIP requirements.
Bonus depreciation and ADS elections
The revenue procedure provides taxpayers with additional flexibility regarding the election to use ADS under Section 168(g)(7), which generally provides longer recovery periods, in lieu of GDS and bonus depreciation elections under Section 168(k). Absent this guidance, these elections would need to be made on timely-filed federal income tax returns (including extensions) and are irrevocable once made.
These procedures apply to tax years ending in 2018, 2019 or 2020 for which taxpayers have already filed the respective federal income tax return(s) prior to April 17, 2020. The affected elections include:
- Section 168(g)(7), which provides an election to depreciate a class of property placed in service by a taxpayer during the taxable year under the ADS
- Section 168(k)(5), which provides an election to deduct the cost of a specified plant in the year in which the it is planted or grafted
- Section 168(k)(7), which provides an election out of bonus depreciation for qualified property placed in service during the taxable year on a class-by-class basis
- Section 168(k)(10), which provides an election to deduct 50%, instead of 100%, bonus depreciation for all qualified property acquired after Sept. 27, 2017, and placed in service in the year that includes Sept. 28, 2017
A taxpayer that wants to file either a late ADS or bonus election, or a revocation of a bonus election (but not a withdrawal of an ADS election) may either: (1) file an amended federal income tax return, amended Form 1065 or AAR, as applicable, for the taxable year in which the property was originally placed in service on or before Oct. 15, 2021 (but not after the applicable period of limitations on assessment), or (2) attach a Form 3115 to the first or second federal income tax return for the year after the year in which the affected assets were placed in service (or, if later, on a tax return that is timely-filed between April 17, 2020, and Oct. 15, 2021). A partnership subject to BBA may have a different time to file pursuant to Rev. Proc. 2020-23 as described above. For more details on Rev. Proc. 2020-23, see our story, “IRS eases BBA rules for 2018, 2019 amended returns.”
For a taxpayer that wants to file a withdrawal of a previously made ADS election, the taxpayer may only file an amended tax return under the procedures laid out above and is not afforded the option to file a Form 3115.
Similar to amending for QIP, an amended return or AAR must include the adjustment to taxable income for the late election or revocation and any collateral adjustments to taxable income or tax liability. If returns have been filed for years subsequent to the year that is being amended, such years must also be amended for all collateral adjustments to taxable income or tax liability.
The revenue procedure modifies the current list of automatic method changes in Rev. Proc. 2019-43 by adding a new change in Section 6.20. This change can be filed concurrently on the same Form 3115 with impermissible to permissible depreciation changes and/or including a change to QIP that is outlined above.
Grant Thornton Insight:
Rev. Proc. 2020-25 creates an opportunity for taxpayers to review the elections made, deemed to be made, or not made, and to consider making tax beneficial changes. Fiscal year-end taxpayers that are described in both this revenue procedure and Rev. Proc. 2019-33 may choose the guidance that is more favorable to them, which adds another opportunity for planning.
Next steps
The guidance provides a wonderful opportunity for taxpayers to reassess their depreciation circumstances in response to changes made by the CARES Act. Taxpayers have flexibility in determining how to make these changes. However, they should consider both the time it may take to implement these changes and the impact they may have on other aspects of their tax return filings, such as charitable contribution limitations, foreign-derived intangibles income (FDII) deductions, Section 163(j) interest expense limitations, Section 481 adjustments and general business credits.
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