Don’t Understand Bonus Depreciation?
Before 2001, an improvement to the interior of a commercial property was depreciated over the life of the building—usually 39 years.
As part of the Economic Stimulus in 2001, §168(k) was passed (§168 is the Accelerated Cost Recovery System). §168k allowed 50% bonus depreciation on qualifying assets.
The description of bonus depreciation can be confusing because it sounds like MORE depreciation, but it’s not. Bonus is taking all assets with a class life of less than 20 years and taking 100% of that asset’s depreciation in one year.
While Section 168(k) allows a bonus depreciation deduction, Section 168(e) classifies property into class lives so taxpayers can decide which properties can and cannot take bonus depreciation.
In 2001, new class lives of assets were added to Section 168(e). This is when bonus really impacted the real estate industry. Each new asset type had a 15-year life and qualified for 50% bonus. They were qualified leasehold improvements, qualified restaurant property, and qualified retail improvement property. Each of these classes of assets was outlined differently, and each one had unique qualifying requirements.
As a side note, these were put under an umbrella called Qualified Improvement Property or QIP. The QIP simplified these assets as “any improvement made to the interior portion of a nonresidential building any time after the building was placed in service.” But QIPs were not available for bonus until 2020.
The Tax Cut and Jobs Act in 2017 amended §168(b)(e) and (k) once again. Now property placed in service after September 27, 2017, could take 100% bonus depreciation. This allowed for real estate to boom. Under the TCJA, bonus depreciation can be taken on qualified property with a class life of 20 years or less.
Bonus is assumed to be taken UNLESS a CPA opts explicitly out.
Section 168(k)(7) allows an election out of bonus for any class of property that is qualified AND placed in service during the taxable year. Section 168(k)(10) also allows taxpayers to make an election to take 50%, rather than 100%, bonus. The election out of bonus, or to use 50% bonus must be made by filing a statement with a timely filed IRS Form 4562.
Back to QIPs, Revenue Procedure (Rev-Proc) 2020-25 provided taxpayers with unique options for implementing the retroactive changes to bonus depreciation available for QIPS, which were placed in service after December 31, 2017, but this was only for tax years 2018, 2019, or 2020.
Rev-Proc 2020-25 permits a taxpayer to file an amended return or a change in accounting method to change the depreciation of QIP placed in service after December 31, 2017.
These temporary solutions were limited to the first or second tax year after the QIP was placed in service or to accounting method changes (Form 3115) made with a timely filed return between April 17, 2020, and October 15, 2021.
As of January 1, 2023, bonus depreciation is slowly being phased out. In 2023 only 80% of qualified property is eligible for bonus. The rest can be applied in the future, but a net operating loss is not allowed, and bonus can now be applied to 80% of a taxpayer’s income.
Although 2022 is behind us, it’s not too late to do a cost segregation study with TPTM. Cost segregation studies can be completed on eligible properties before October 15, 2023.