And what does bonus depreciation mean for real estate owners?
Prior to 2001, the purchase of a commercial building or an improvement/renovation done to the interior of a commercial building was depreciated over the structural life of the building, which is 39 years.
As part of the Economic Stimulus package passed in 2001, §168(k) was introduced in the package. §168(k) allowed 50% bonus depreciation on qualifying assets and created a massive opportunity for real estate owners and investors. §168(e) classifies property into class lives so tax professionals (along with a cost segregation study) can decide which building sections can take bonus depreciation.
Bonus depreciation may not be an inaccurate description of the tax-saving opportunity because it sounds like there is MORE depreciation with a bonus and less without it. But that is not the case. Bonus is taking all the depreciation on building assets with a class life of less than 20 years in one single year.
In 2001, new class lives of assets were also added to Section 168(e). These additions are when bonus depreciation really affected the entire real estate industry. Qualified interior improvements now 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 defined differently, and each had different requirements.
Fast forward to 2017; these asset classes were all put under an umbrella called a QIP, which means qualified improvement property. 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.” However, QIPs were mistakenly put in a 39-year class life and were not available for bonus depreciation until 2020.
The Tax Cut and Jobs Act in 2020 amended §168(b)(e) and (k), allowing a new building or purchased property placed in service after September 27, 2017, to take 100% bonus depreciation on class lives under 20 years.
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 life under 20 years if it is placed in service during the current 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 options for going back and applying bonus retroactively. Rev-Proc 2020-25 permitted 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. However, very few CPAs took advantage of this.
This opportunity was limited to the first or second tax year after the QIP was placed in service.
All good things come to an end, and that includes bonus depreciation. In 2023, only 80% of qualified property is eligible for bonus. The rest can be applied in the future.
Although 2023 is behind us, it’s not too late to do a cost segregation study with KAJMST. Cost segregation studies can be completed on eligible property before the tax filing deadline on October 15, 2023. If your cost segregation representative doesn’t understand bonus depreciation, the real estate professional status, the Tangible Property Regulations, OR the difference between Schedule E and Schedule C, FIND A NEW ONE.