The CARES Act ushered in several changes that had a positive impact on real estate owners.  One provision that had a huge immediate impact was the retroactive correction of the recovery period for assets defined as Qualified Improvement Property (QIP) under the TCJA.  By defining the recovery period of these assets as 15-year straight line, they become eligible for the TCJA 100% bonus provision.  Many people heard this news and assumed that all post-TCJA interior improvements can be designated as QIP and therefore receive 100% bonus.  In other words, people think that if an interior space underwent a gut renovation on or after 1/1/2018, all associated spend can be designated as QIP.

We here at Capstan have heard this line of thinking quite a bit lately, and we caution our clients to step back and review the definition of TCJA-QIP before making any assumptions.  It cannot be assumed that all improvements made on after 1/1/2018 automatically qualify as TCJA-QIP.  There are several nuances that need to be considered.

To clarify exactly what TCJA-QIP IS – and what it is NOT – we need to return to its official IRS definition.

Since its inception under the PATH Act, QIP has been defined as any improvement made by the taxpayer to an interior portion of a building that is nonresidential real property as long as that improvement is placed in service after the building was first placed in service by any taxpayer (Section 168(k)(3)). QIP specifically excludes expenditures for (1) the enlargement of a building; (2) elevators or escalators; (3) the internal structural framework of a building.

Let’s examine some key parts of this definition:

Interior portion: this means that improvements to the exterior of a building – façade, roof, etc. are NOT QIP.  Similarly, land improvements performed on the land surrounding the building are also NOT QIP- eligible.

Nonresidential: this means that improvements to a residential facility are NOT QIP.  Improvements made to multi-family property or nursing homes are not QIP-eligible.

Real property: this means that personal property, i.e. code section 1245, such as 5-year class life assets, are NOT QIP-eligible.  Sometimes people think that since 5-year assets and QIP are both eligible for 100% bonus, they can be lumped together and treated identically.  This is incorrect.

Enlargement: any expenditure that would increase building footprint is specifically excluded from QIP.  This means that any spend on additions is NOT QIP-eligible.  If you had a project that was a combination renovation and addition, you could take QIP on the renovation portion of the project, but not on the addition portion.

Structural framework: any expenditure for the internal structural framework of the building is specifically excluded from QIP.   Things like load-bearing walls, columns, girders, etc. are NOT QIP-eligible.

A few other things to keep in mind:

• Some parts of a building system may be classified as QIP, while other parts may not. For example, in an HVAC renovation, the ductwork and control systems within the building may be considered QIP, but the rooftop units would not.
• QIP is primarily useful in scenarios where the current owner renovates his property. In an acquisition scenario, a new owner is not permitted to take QIP on improvements made by the previous owner.

Although not all improvements can be classified as QIP, a Cost Segregation Study will properly allocate QIP, personal property, land improvements, and base building assets to ensure that the owner is in a defensible position in the rare case of an IRS audit.  There’s so much opportunity right now – QIP, personal property, and land improvements are all eligible for 100% bonus depreciation.  The key to capturing that opportunity is accurate classification of each asset category through cost segregation.

If you would like to learn more about QIP as part of your comprehensive tax strategy – contact Bruce Johnson, Capstantax.