In the past few weeks, we have looked at many of the economic stimulus and consumer protection parts of the CARES Act. A minor section in the Act has also corrected the “Retail Glitch” of 2018’s Tax Cuts and Jobs Act (TCJA). This correction will now allow business owners to depreciate improvements and equipment – including restaurant equipment – much faster than before. It may also entitle businesses to amend tax returns for 2018 and 2019 and even receive a refund.
What was the Retail Glitch?
The TCJA intended to allow business owners to depreciate their qualified leasehold improvement property, restaurant property, and retail improvement property (collectively “Qualified Improvement Property” or “QIP”) over 15 years. The TCJA also contained a provision for “Bonus Depreciation.” Provided that it has a depreciation period of fewer than 20 years, bonus depreciation allowed 100% of the value of this QIP to be depreciated in the year that the leaseholder placed the property into service. For example, a business owner could have deducted up to $ 1 million of QIP in the year that they put improvements put in place.
Unfortunately, TCJA did not include QIP in the list of items with a 15-year depreciation period. That meant that QIP was not eligible for bonus depreciation, and the TCJA actually required it to be depreciated over 39 years.
How did the CARES Act fix the Retail Glitch?
The CARES Act has fixed this drafting error, and QIP is now generally depreciable over 15 years. Because of this change, QIP is also eligible for bonus depreciation if it was acquired and placed in service after January 1, 2018, but before January 1, 2023.
This correction applies retroactively. That is, the CARES Act allows a taxpayer to amend their 2018 and 2019 tax returns to take advantage of the bonus depreciation. Amending your returns could result in refunds on the taxes paid during those years.
Exceptions to Bonus Depreciation for QIP
There are a few qualifiers and exceptions to this benefit. I will not go through them all, so you should discuss this issue with your tax professional. But generally, some of the noteworthy exceptions are:
- QIP must have been acquired during the applicable period. If you put the QIP into service before January 1, 2018, for example, the old rule limits bonus depreciation to only 50% of the costs.
- Generally, QIP must be new. It cannot be property that a business or affiliate used before or that the business purchased if the property was used to calculate the seller’s basis in the property.
- If the business made an election under Section 163(j)(3) of the Tax Code, they are not eligible for bonus depreciation. Very generally, Section 163(j) of the Tax Code limits the amount of interest expense that a business can deduct. Certain kinds of businesses, including a “real property trade or business,” can make an irrevocable election avoid this limitation.
- For partnerships, a tax refund is generally not available for 2018 and 2019 returns. If the partnership elects to adjust the returns for those years, they should receive a tax credit for the year that the adjustments were filed. There are new, complicated rules for auditing partnerships that come into play with this correction. You should definitely talk to your tax professional about this.
Even without the bonus depreciation, the correction in the CARES Act also clarifies depreciation rules for improvement property. For example, restaurant equipment now gets a useful life (for tax purposes – your mileage may vary) of 15 years instead of 39.
Overall, bonus depreciation provides useful options for businesses that qualify. Make sure that you discuss these issues with your financial team, including your accountant, attorney, banker, and others.