The CARES Act expands allowable tax deduction for commercial property improvements

The $2 trillion CARES Act includes a tax law change that may benefit cash strapped commercial property owners and tenants and promote increased fit-up spending well after the COVID-19 pandemic runs its course. This change expands the allowable tax deduction for many kinds of commercial property improvements to 100% of their cost, with the deduction applicable right away.

Because the change is retroactively effective to January 1, 2018, businesses who have recently incurred costs for qualified improvement property (“QIP”)[1] may consider amending earlier tax returns to take advantage of accelerated depreciation alternatives and receive refunds. This new tax change should also incentivize owners and commercial tenants to make property improvements while realizing after-tax savings.

The TCJA “Error”

Prior to the Tax Cuts and Jobs Act (the “TCJA”) enacted in 2018, many interior improvements to nonresidential buildings and certain business equipment were eligible for 50% bonus depreciation as QIP. The TCJA intended to enhance the tax benefit then in effect for QIP by upping the deduction from 50% of the cost of improvements to 100% and to expand the types of improvements covered. Rather, the TCJA unintentionally excluded QIP from any bonus depreciation eligibility.

Specifically, Congress intended the TCJA to change the depreciation period for QIP from 39 years to 15 years and to allow a 100% write-off for certain property acquired after Sept. 27, 2017, and placed in service before Jan. 1, 2023. However, the text of another provision of the TCJA omitted reference to nonresidential interior improvements in a way that made them ineligible for this intended treatment.

This textual error created two problems: (1) QIP had a longer-than-intended depreciation period, and (2) QIP was not eligible for the immediate expensing provided by the TCJA because that benefit was only available for assets with a depreciable life of 20 years or fewer.

The CARES Act “Cure”

Congress has now acted to correct its earlier TCJA error. Pursuant to the CARES Act businesses can now depreciate QIP over a 15-year period or immediately expense its cost if certain other requirements are met. Commercial property owners will benefit, but so may tenants who heavily invested in the fit-up of space.

There are two foreseeable benefits. First, because the CARES Act change is retroactive to January 1, 2018, businesses who previously made qualified interior improvements should consult with their tax advisors to amend prior tax returns[2] and seek a refund. Since bonus depreciation of 100% of an asset’s cost is allowed in 2018 and 2019, this change can provide immediate cash saving opportunities.[3] Second, over the longer term while the economy recovers, the change should help businesses realize after-tax savings and free-up cash flow incentivizing further property improvements.

[1] Qualified improvement property was 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 specifically excludes expenditures attributable to the enlargement of the building, any elevator or escalator, or the internal structural framework of the building. Under the CARES Act, the definition is now amended to include only interior improvements “made by the taxpayer.” This may be a significant change because of the impact on new property acquisitions. Previously, a portion of the purchase price of an acquired building may have been considered QIP and thus eligible for bonus depreciation by the purchaser. This is no longer possible. The QIP depreciation will only apply to improvements actually made by the reporting taxpayer.
[2] Instead of amending earlier returns, some businesses may file an application for change in accounting method to take advantage of the more favorable treatment, or a superseding tax return. The specifics of each alternative should be discussed with your tax advisor, but each method can result in current refunds of taxes previously paid.
[3] Additional bonus depreciation may create net operating losses (“NOLs”) for certain taxpayers, which can be carried back five years under the new NOL provisions of the CARES Act to create further tax savings. For example, C corporations are now taxed at 21% as compared to the historical 35% rate. An NOL generated in 2018 or 2019 by a C corporation would only provide a 21% tax benefit in future years. But, because an NOL can now potentially be carried back to prior years where 35% was the maximum tax rate, this NOL may now also generate a tax benefit at a higher tax rate.