On Friday March 27th, the President signed the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) into law. This $2 trillion dollar stimulus bill will provide relief to individuals, businesses, and state and local governments, and will bolster an economy gravely shaken by the unprecedented impact of the Coronavirus.
This Act contains several provisions relevant to commercial real estate and depreciation. Most significantly, Qualified Improvement Property (QIP) will be treated as 15-year property under the Tax Cuts and Jobs Act (TCJA), and therefore will be eligible to qualify for 100% bonus. This change will be retroactive to January 1st, 2018.
This long-awaited technical correction will undo the notorious “QIP glitch.” TCJA architects intended for the recovery period of QIP to be 15-years. Unfortunately, in a drafting error, the new QIP was never actually put into Section 168(e)(3)(E), the subparagraph that lists assets eligible for a 15-year class life. As such, under the TCJA, QIP had to be treated as 39-year class life and was not eligible for bonus treatment. (Recall that bonus-eligible property must have a recovery period of 20-years or less.)
By correcting this error, the CARES Act will provide a tremendous boost to real estate owners and businesses that have invested in interior improvements since 1/1/2018
Other relevant CARES Act legislation:
Raises the limitation on deductible business interest from 30% to 50% of earnings before interest, taxes, depreciation, amortization for 2019 and 2020.
Temporarily repeals the 80% income limitation for net operating loss deductions for years beginning before 2021. For losses arising in 2018, 2019, and 2020, a five-year carryback is allowed (taxpayers can elect to forgo the carryback).
Repeals the Sec. 461(l) excess loss limitation. Sec. 461(l) was added to the Code by the law known as the Tax Cuts and Jobs Act, P.L. 115-97, and it disallows excess business losses of non-corporate taxpayers if the amount of the loss exceeds $250,000 ($500,000 for married taxpayers filing jointly).
Excludes from income the cancellation of debt related to new, emergency small business loans.
On Friday April 10th, the IRS released Rev. Proc 2022-22 to provide guidance on how to make changes for previous tax decisions made under the TCJA rules. Rev. Proc 2022-22 permits revocations of elections-out-of-163(j) made in 2018 or 2019 tax returns and allows late elections-out-of-163(j) back to 2018, if a taxpayer chooses. It also allows BBA partnerships to file amended returns to make the corrections. This is a tremendous win for taxpayers by helping previous tax decisions.
As established in the TCJA, the 163(j)-election permitted eligible taxpayers to elect out of the interest deduction limitation, capped at that time at 30% of adjusted taxable income, after certain adjustments. Many companies did choose to elect out, but that decision came with a price – these companies generally had to depreciate Residential Real Property (30 years), Non-Residential Real Property (40 years) and Qualified Improvement Property (20 years) using the longer-lived Alternative Depreciation System (ADS) instead of MACRS class-lives. Furthermore, properties depreciated using ADS are generally not eligible for bonus depreciation. Nonetheless, at that time it made financial sense for many taxpayers to elect out of the interest deduction limitation, even if that meant ADS class lives and no bonus eligibility. Only assets with a class life of 20-years or less are eligible for bonus depreciation, and these ADS class lives exceed that threshold. Furthermore, due to a TCJA drafting error, the MACRS class life of Qualified Improvement Property (QIP) was 39-year at that time, so bonus was not in play for QIP under MACRS depreciation either.
However, the recent correction to QIP class life means that a decision made in 2018 may no longer be the best decision. This Rev. Proc. allows taxpayers to rethink their choice, allowing them to create new late elections-out-of-163(j) back to 2018, or, in what is likely to be more common, allowing them to revoke elections-out-of-163(j) previously made on 2018 or 2019 tax returns.
As noted above, the CARES Act corrected the recovery period of QIP to 15-year, thus characterizing it as property eligible for bonus depreciation. Now that QIP is eligible for 100% bonus depreciation under the TCJA, many taxpayers who initially chose to opt out of 163(j) are starting to rethink that decision. Admittedly they will lose some interest expense, but access to MACRS class lives and bonus depreciation on QIP means that it might be the right call.
If a taxpayer does act on this Rev. Proc., it is important to note that there are collateral adjustments required. If a taxpayer revokes their election-out-of-163j, they must then determine if they are now subject to the interest deduction limitation. They also must re-state their depreciation method from ADS back to MACRS and claim any associated bonus if eligible. They must also adjust their returns for any other items that are impacted by the change in taxable income.
Bruce Johnson is Founding Partner of Capstan Tax Strategies. He can be reached at (215) 885-7510 or firstname.lastname@example.org.