The Coronavirus Aid, Relief, and Economic Security (CARES) Act established the Paycheck Protection Program, authorized stimulus checks for many Americans, and provided other economic relief for individuals and businesses. One provision that should not be overlooked corrects a technical glitch that has deprived many restaurants and other businesses of accelerated depreciation deductions for certain building interior improvements over the last few years. The correction is retroactive to January 1, 2018, so there is an opportunity for eligible restaurants to claim missed depreciation deductions, recover the tax benefits they would have enjoyed and improve their cash flow.
Related Read: Paycheck Protection Program: Additional Money, Loan Forgiveness and Other Guidance
The Qualified Improvement Property Glitch
Generally, nonresidential buildings (and improvements to those buildings) are depreciable over 39 years. At one time, several categories of property — including qualified restaurant property — were depreciable over 15 years and potentially eligible for bonus depreciation. Bonus depreciation allows a taxpayer to deduct a portion of a qualifying asset’s cost (currently 100%) up front, in the year it is placed in service. (Note: 100% bonus depreciation is available through 2022, after which it will be reduced by 20% each year and eliminated after 2026.)
The Tax Cuts and Jobs Act of 2017 (TCJA), in an effort to simplify the tax code, consolidated the various types of nonresidential building improvements into one of the existing categories — qualified improvement property (QIP) — starting in 2018. QIP generally refers to improvements a taxpayer makes to the interior of an existing nonresidential building. Common examples include installation or replacement of drywall, ceilings, interior doors, fire protection, mechanical, electrical and plumbing. QIP does not include improvements attributable to elevators or escalators, the building’s internal structural framework or enlargement of the building.
Congress’s intent was to establish a 15-year recovery period for QIP and to make it eligible for 100% bonus depreciation. (Generally, bonus depreciation is available for depreciable business assets with a recovery period of 20 years or less.) Unfortunately, as a result of a drafting error, the TCJA assigned QIP a 39-year depreciable life. That meant that restaurants, retail establishments and other businesses had to write off investments in interior refreshes and other improvements over 39 years and could not claim bonus depreciation.
The QIP Fix
The CARES Act includes a long-awaited technical correction, reducing the depreciable life of QIP from 39 years to 15 years, retroactive to January 1, 2018. As a result, restaurants that placed qualifying interior improvements in service on or after that date are now eligible to claim 100% bonus depreciation on those improvements and to recover any tax benefits they missed on previously filed tax returns.
There are several options for taking advantage of the technical correction. One option is to file amended tax returns for the relevant years to reflect the appropriate amount of depreciation and seek a refund of any overpayments (Note: If you have already filed your 2019 return, you have until the extended due date to file a superseding return to correct any depreciation issues). Amending returns can be cumbersome, especially for partnerships or other pass-through entities with many owners. In that case, a more practical option may be to file Form 3115, Application for Change in Accounting Method, to claim “catch up” depreciation deductions in the current year.
As you review your options, be sure to consider the relationship between depreciation and other areas of the tax code. For example, taxpayers that elect out of the limitations on business interest deductions are ineligible for bonus depreciation. And added depreciation deductions may have an impact on net operating losses and other tax attributes. It is important to weigh the benefits of increased depreciation deductions against potential tax costs in other areas.
If your restaurant invested in improvements to its premises in recent years, it pays to explore whether you are entitled to a tax refund for missed depreciation deductions, including 100% bonus depreciation. To maximize the deductibility of improvement costs, consider conducting a cost segregation study to distinguish between QIP and non-QIP costs.
For more information about maximizing depreciation of restaurant assets, please contact Brian R. Israel. Visit ORBA.com to learn more about our Restaurant Group.