Note: This article is not meant to offer tax advice, nor is it meant to be taken as such. Due to conditions caused by the coronavirus, updates to tax regulations and laws can occur at any time. As always, contact your tax advisor for specific information pertaining to your situation.
The CARES Act (Coronavirus Aid, Relief, and Economic Security Act) was signed into law on March 27, 2020. Two key non-payroll tax-related provisions in the CARES Act are 1) Qualified Improvement Property (QIP) is, once again, treated as 15-year bonus-eligible property and 2) a Net Operating Loss (NOL) carryback period has been reinstated for losses incurred in 2018, 2019, and 2020. Both of these tax provisions were eliminated as part of the 2017 TCJA (Tax Cuts and Jobs Act).
At this point, you may have realized that the change for QIP is not simply a depreciation change, but could potentially have a significant impact in the areas of fixed asset management, capital expenditure (CapEx) planning, and be the difference between having a taxable loss versus taxable income.
Before going further, reading the following points may help you get more out of this article:
- This information only applies if you have Qualified Improvement Property (QIP) assets, particularly those placed in service in either or both 2018 and 2019.
- It only applies to QIP that you, the taxpayer, put into service or for which you provided a tenant allowance.
- The IRS has not yet issued guidance regarding the changes to QIP. This guidance may include approaches used in the past or introduce something new.
- IRS Form 3115 Application for Change in Accounting Method is used to request a change in either an overall method of accounting or the accounting treatment of any item. It may be used for changes to depreciation that are not mathematical or posting errors. The related adjustment amount is generally referred to as a 481(a) adjustment.
How did the rules for QIP change?
The assignment of a 39-year life to QIP placed in service after 12/31/2017 under the TCJA is commonly known as the “retail glitch” (i.e. stores and restaurants were highly impacted). The CARES Act retroactively fixes this unintended error and is written in such a way that the TCJA itself was amended and QIP is treated as if it was always 15-year property, even if placed in service after 12/31/2017. In other words, QIP which had a GDS life of 39 years and ADS life of 40 years now has a GDS life of 15 years and ADS life of 20 years, thus making it eligible for the bonus deduction in 2018 and later. Under current law, this is a 100% bonus deduction.
The article Breaking News: Qualified Improvement Property Now Has a 15-year Life! has a chart showing the significant impact of depreciating a $100,000 QIP asset using bonus versus other scenarios. The article also covers ways to update Sage Fixed Assets – Depreciation for your QIP assets.
What factors could affect my tax return option(s)?
Whether your motivation is to take advantage of potential tax savings or simply comply with the new 15-year life requirement, you need to know your options. Before getting to the options, here is a list of factors to consider before updating or filing your tax returns.
Entity type: Each entity type such as S-Corporations, Partnerships, especially large ones, C-corporations, single member LLCs, and sole proprietorships have their own tax nuances which could affect your course of action.
Tax Year: First, only calendar year tax year filers (January-December) have had their filing due date moved to July 15 for all entity types. Now, fiscal year filers (and other types of filings) have also been granted special filing status up to a certain date. See the “Resources” section below.
Extensions: A return extended on July 15 will still only generate an extension to the normal extended due date of September 15 or October 15, depending on entity type.
Section 179: Was a Section 179 Deduction taken in whole or part for 39-year QIP? Should you leave the Section 179 Deduction in effect when applying the new life? Should you take 100% bonus instead?
Bonus Election: With the new 15-year QIP life, you now have the option of electing out of bonus. This may be desirable, especially if your company has generated losses from normal operations.
Expected Net Income: Does your company expect to generate taxable income in 2020 or 2021. Are losses from prior years being brought forward?
Losses: Changing the QIP to a 15-year life and taking 100% bonus may cause what was previously taxable income to become a taxable loss for the year, which would increase existing Net Operating Losses (NOLs), if any.
Other CARES Act changes: NOLs generated from 2018, 2019, and 2020 can now be carried back five years or forward indefinitely. The Excess Business Loss rules that limited the amount of losses a sole proprietor and entities taxed that way (e.g. single member LLCs) have been deferred to 2021 as if they didn’t exist for the years 2018-2020. When reclassifying QIP as 15-year property, it is not only about the QIP changes, but also coordinating with the modified loss rules and other rules not discussed in this article that were changed by the CARES Act.
Filed returns: Your options depend on which returns you have and have not filed. 1) Haven’t filed for 2018 or 2019 – just complete the returns with the latest rules 2) Filed 2018 only – you have several options including filing an amended return or a Form 3115. 3) Have filed 2018 and 2019 returns – this is more complicated. The best option may be to wait for IRS guidance.
What are the options?
The options below are mostly geared toward the reclassification of QIP as 15-year property, but other tax changes may need to be considered also. This list is only presented for purposes of discussion and is not meant to be all inclusive or to be seen as advocating one option over another. It may be that a combination of options will generate the best results for a particular situation, depending on the year.
#1 Wait until the IRS issues guidance
Update: see IRS Releases Qualified Improvement Property (QIP) Guidance for coverage of Revenue Procedure 2020-25.
The IRS will issue guidance regarding QIP in the coming months. Since the first filing date has been pushed back to July 15 and returns can be extended into the fall, there is no need to rush into a filing decision without all of the information. No one is sure what the guidance will be, it could include approaches used in the past or introduce something new.
Caveats: the IRS may not issue timely guidance and you will have to determine the best course of action with the information you have available.
Consider using for: 1) a 2018 return already filed 2) both 2018 and 2019 returns filed – the IRS may introduce a specific solution for this scenario.
#2 File an amended return
Per the IRS, an amended return is a subsequent return filed after the expiration of the filing period (including extensions) of October 15, for example. Filing an amended return is a straightforward way to combine your QIP depreciation recalculation with other adjustments, data entry errors, and omissions. If an NOL is generated due to the QIP change in 2018, for example, it shows up on the amended 2018 return. This keeps it in the year that it occurred versus a Form 3115 filing.
Reclassify any QIP as 15-year property, calculate the new depreciation amounts, subtract the old 39-year depreciation amounts and enter this and other adjustments, if any, on the amended return
Caveats: 1) This approach may be more expensive or cumbersome than other approaches permitted by the IRS may permit. 2) Your “new” 2018 numbers need to flow properly into the 2019 tax return beginning balances. 3) You may have to file the amended return using a paper return 4) Your 2018 financial and tax records may become out of sync.
Consider using for: 1) a 2018 return already filed 2) a filed 2019 return that is the only year you had a QIP change.
#3 File a superseding return
Per the IRS, a superseding return is a subsequent return filed within the filing period (including extensions). If you had filed your original 2019 tax return before the CARES Act passed, you could prepare a “superseding” return with the modified QIP depreciation and file that version to the IRS before July 15, for example, as the one you want to be processed.
Caveats: 1) If the return is not clearly identified as superseding, the IRS will reject it as a duplicate.
Consider using for: 1) a 2019 return filed before the due date including extensions.
#4 File a Form 3115
The CARES Act is written in such a way that the TCJA itself was amended and QIP is treated as if it was always 15-year property. In other words, this means that the use of a 39-year life for QIP is likely to be treated as an impermissible method by the IRS and would be recorded as an Automatic change for Depreciation on the Form 3115. The Form 3115 is generally filed with tax return in the year of the change (e.g. 2019).
The 481(a) adjustment in this case is considered a negative adjustment because it reduces taxable income; a negative adjustment can generally be taken all at one time; and would be recorded on your tax return as “Other Expenses” and not on the Form 4562.
Caveats: There is only space for a few 1) The information above is not an official IRS position regarding the CARES Act changes, but is a summary of existing rules that one would expect to apply, unless the IRS issues special rules for the QIP change, for example. 2) Filing a Form 3115 versus an amended return could move a potential NOL from 2018 into 2019, for example, because the deduction would be taken in 2019.
Consider using for: 1) depreciation taken on a 2018 return already filed 2) though conceivable, but perhaps not the best option, for depreciation taken on a 2019 return (i.e. when filing the 2020 tax return).
#5 Do nothing
Yes, this is an option. This option would mostly apply in cases where partnerships have made certain elections, especially large ones, or the amount of QIP assets placed-in-service so far are immaterial to the overall fixed asset, depreciation, and ultimately taxable income amounts. What amount is immaterial? Every situation is different.
Caveat: Technically the law changed and doing nothing means you are out of compliance. Discuss the available options with your tax advisor.
Consider using for: 1) a 2018 return already filed 2) a 2019 return already filed. An unfiled return can still be changed.
What other information should I keep in mind?
- Always make a backup of your system before making changes to your assets.
- Save a copy of your Depreciation Expense, Tax Expense, and Form 4562 from both before and after making the changes to your QIP assets.
- States may or may not follow the new Federal rules, much less having had the time to make legislative changes.
- Be sure to consider the whole tax and financial situation, as well as other provisions in the CARES Act, that could impact the best way to proceed for your company.
- Do not rush into hasty decisions. For most organizations there is still time to plan the best course of action.
Since things are changing so fast, it seemed helpful to post as much related information as possible. Don’t feel obligated to read every link. Read only those that interest you or apply to your situation. The four more recent/directly beneficial articles for most readers are at the top.
- IRS Releases Qualified Improvement Property (QIP) Guidance
- Breaking News: Qualified Improvement Property Now Has a 15-year Life!
- Proc. 2020-25 IRS Qualified Improvement Property and Bonus guidance
- KB ID:17382 How to add or edit QIP with a 15 year life
- Proc. 2020-24 Amended NOL carryback rules
- N-2020-23 Update to N-2020-18 expanded tax relief for individuals, businesses & others
- Proc. 2020-23 Allows partnerships to file amended returns as an alternative to AAR
- Proc. 2020-22 Amended 163(j) Interest Rules
- CARES ACT text S.3548 -116th Congress