Tax Saving Tip: Bonus Depreciation Deduction

Do you own or lease non-residential (think commercial) real property for your business or rent non-residential real property to others?

If so, interior improvements you make to the property may be fully deductible in a single year instead of over multiple years.

But to be deducted instantly, the improvements must fit into the category that the tax code calls “qualified improvement property” (QIP).

What Is QIP?

Ordinarily, non-residential real property is depreciated over 39 years. And so are improvements to such real property after it is placed in service.

But Congress wants to encourage business owners to improve their properties. So, starting in 2018, the Tax Cuts and Jobs Act (TCJA) established a new category of depreciable real property: QIP, which has a much shorter recovery period than regular commercial property—15 years. But even better, for tax years 2021 and 2022, QIP can qualify for that immediate 100 percent bonus depreciation deduction.

QIP consists of improvements, other than personal property, made by the taxpayer to the interior of non-residential real property after the date the building was first placed in service. For example, QIP includes interior improvements or renovations to any of the following:

• Office building (or single offices)
• Restaurant or bar
• Store
• Strip mall
• Motel or hotel
• Warehouse
• Factory

Since QIP applies only to non-residential property, improvements to residential rental property such as an apartment building are not QIP.

Transient Property

Airbnb and similar short-term residential rentals also qualify as non-residential property if they are rented on a transient basis—that is, over half of the rental use is by a series of tenants who occupy the unit for less than 30 days per rental.

QIP Examples

Examples of interior improvements that can receive QIP treatment include the following:

• Drywall
• Ceilings
• Interior doors
• Modifications to tenant spaces (if the interior walls are not load-bearing)
• Fire protection
• Mechanical
• Electrical
• Plumbing
• Heating and air interior equipment and ductwork
• Security equipment

QIP does not include improvements related to the enlargement of a building, an elevator or escalator, or the internal structural framework of a building. Structural framework includes “all load-bearing internal walls and any other internal structural supports.”

Placed in Service

QIP consists only of improvements made after the building was placed in service. But for these purposes, “placed in service” means the first time the building is placed in service by any person. By reason of this rule, you can purchase an existing property that was placed in service by an owner anytime in the past, renovate it before you place it in service, and still get QIP treatment.

But you have to make the improvements. You can’t acquire a building and treat improvements made by a previous owner as QIP.

How to Deduct Qualified Improvement Property

You may deduct the cost of QIP in one of three ways:

• use first-year bonus depreciation,
• use IRC Section 179 expensing, or
• depreciate the cost over 15 years using straight-line depreciation.

As mentioned earlier, QIP placed in service in 2021 and 2022 is eligible for 100 percent bonus depreciation. That is, you can deduct the entire cost in one year, without limit.

Starting in 2023, the tax code reduces bonus depreciation by 20 percent per year until it is completely phased out for property placed in service in 2027.

If you would like to discuss QIP, please call me on my direct line at 561-331-7011.