Tax Reform’s Changes to Building Improvements

Is HVAC Qualified Leasehold Improvement Property?

The depreciation rules for building improvements have changed drastically in the last three years. The first major change came with the PATH Act of 2015, and the most recent change came with the Tax Cuts and Jobs Act of 2017. Luckily, almost all of the changes are beneficial to taxpayers. Taxpayers will now have more opportunities to take accelerated depreciation on their building improvements than they ever had before.

Timeline of Changes

Before 2015, building improvements would only be eligible for bonus depreciation if they fit one of the following three categories: (1) qualified leasehold improvement property (QLIP), (2) qualified restaurant property (QRP), or (3) qualified retail improvement property (QRIP). Meeting the requirements for one of these categories proved to be quite difficult. For example, QLIP treatment was only available for improvements on leaseholds, not on owned property. Additionally, improvements that were made less than three years after the building was placed in service did not qualify. Even though it was difficult to be eligible for QLIP treatment, it was desirable; not only did it allow for bonus depreciation, but any remaining cost would be depreciated using a short 15-year recovery period.

The PATH Act of 2015 retained the three categories of property mentioned above, but it also introduced a new category called “qualified improvement property” that would also be eligible for bonus depreciation. This category included improvements made to a nonresidential building at any point after it was placed in service. This broad definition meant that taxpayers did not have to wait the requisite three years before starting construction, and improvements made to buildings they owned (and not just leased) would be eligible. This category also made HVAC systems, security systems, and similar upgrades eligible for bonus treatment, which had been previously disallowed. The main downside to qualified improvement property was that any remaining cost not deducted with bonus depreciation had to be recovered over a lengthier 39-year period.

The Tax Cuts and Jobs Act (TCJA) passed in December 2017 changed the rules once again. It removed the older categories of building improvements (the QLIP, QRP, and QRIP) and replaced them fully with the qualified improvement property category. This simplified the process for taxpayers and created additional tax saving opportunities. It also changed the recovery period of qualified improvement property from 39 years to 15 years. Now, taxpayers are not only eligible for a short recovery period, but they are eligible for bonus depreciation on more improvements than they were before.

Potential Hiccup

During the final negotiations of the TCJA, it was clear that Congress intended for qualified improvement property to be eligible for bonus depreciation, just as it was with the passage of the PATH Act. However, the new law does not explicitly state Congress’s intention. We expect to see a corrections bill amending the law, but as it currently stands, qualified improvement property is ineligible for bonus depreciation. Until Congress corrects this oversight, taxpayers should take care when planning their building improvement expenditures.

Interested in learning more about these changes or talking about how to take the uncertainties into account for planning purposes? Contact us. We are here to help. Email | 804.747.0000

Additional Resources: 

Real Estate Investors and Developers: Are You Aware of the Historic Rehabilitation Tax Credit?

High Level Look at Disclosures Required for Revenue Recognition

“How Tax Reform May Impact the Construction Industry and How to Plan for Potential Changes”

Construction contractors should be aware of these special rules for long-term contracts