The Tale of Retroactive Depreciation
Geoffrey Kayton, CPA
02.16.21 | TAX Chat
Recent changes to the depreciation rules provide potential tax benefits to real estate professionals. Recently enacted legislation fixed the mistake made by Congress, known as the ‘retail glitch’. This change, discussed below, accelerates the timing of depreciation deductions for qualified improvement property (QIP), as was originally intended.
The story begins with the Tax Cuts and Jobs Act of 2017 (TCJA). The drafting of this bill was hurried, and it showed. The TCJA created a new class of property – QIP. QIP primarily replaced three types of property, that existed prior to the TCJA, which were qualified leasehold improvements, qualified retail improvements, and qualified restaurant improvements. Generally, QIP is work done to the internal portion of commercial buildings (excluding structural or elevator work) placed in service after the building itself.
The Error and Consequences
The mistake was that one code section cross-referenced another code section that didn’t exist. Because of this drafting error, the depreciation deductions for QIP were required over 39 years, as opposed to an intended 15 years. Also, QIP was not eligible for 100% bonus deprecation.
On March 27, 2020, the Coronavirus Aid, Recovery, and Economic Security (CARES) Act was enacted and provided a solution for the missing code section; a 15-year life for QIP was inserted (which also means it qualifies for 100% bonus depreciation). The problem: potentially two years’ tax returns had already been filed that need to be corrected.
More recently, a section of the Consolidated Appropriations Act (CAA), shortened the alternative depreciation life for residential rental property from 40 years to 30 years (retroactive to 2018) for taxpayers that are electing real property trades or businesses. Prior to the CAA, real estate businesses that opted out of the TCJA’s interest expense limitation were required to take residential depreciation deductions, for assets in use prior to September 27, 2017, over 40 years. Generally, the depreciation deductions for that same asset are allowed over 27.5 years. That’s an approximate 31% decrease in the annual depreciation deduction. The CAA retroactively (to 2018) allows these assets an alternate life of 30 years, which is only a 9% reduction in annual depreciation deduction.
Clean Up Time
So now all is well with the universe, right? Prospectively, yes, but now we must clean-up the mess left by these retroactive changes. If you are a real estate professional, and these issues affect you, the application of these changes can drastically change the amount of tax due and its timing.
Questions: I can be reached at 212.331.7525 | firstname.lastname@example.org or contact your Berdon advisor for guidance.
Geoffrey Kayton is a Tax Manager with more than 10 years of professional experience. He advises a diverse array of clients across the real estate sector on a variety of tax matters.