Complexities Emerge In The OZones: QIP

This news might confound all those "Buy-and-Hold" and "Wait-and-See"  throngs of investors who piled-in prematurely into Opportunity Zones . . . and at the same time help to inform and explain for  the general public what plans investors make for the restoration of neglected downtown commercial space acquisitions here in The Old Donut-Hole for the ten properties on Main Street. 

The Fixtures Fix:

Correcting the Drafting Error Involving the Expensing of Qualified Improvement Property

by Erica York May 30, 2018  

https://taxfoundation.org/fixtures-fix-qualified-improvement-property/ 

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Introduction

Removing barriers to business investment in the United States was one of the central goals of the Tax Cuts and Jobs Act (TCJA), enacted last December. One of the key provisions in the bill, known as “100 percent bonus depreciation,” allows businesses to immediately deduct the cost of short-lived investments—limiting the penalty that the federal tax code placed on businesses that make capital investments in the United States.

However, the law excludes some categories of business investment from 100 percent bonus depreciation.
For instance, many interior improvements to buildings are not eligible for the provision, and will be required to be written off over time periods as long as 39 years. This exclusion is widely believed to have been due to a legislative oversight: Congress seems to have intended building improvements to be eligible for 100 percent bonus depreciation, but left them out due to a last-minute drafting error. As a result, the new tax law actually worsens the tax treatment of this type of investment, which previously qualified for bonus depreciation, by reducing the ability of businesses to deduct their full building improvement costs.

Ideally, all business expenses should be immediately deductible, including the amount that businesses spend on capital investment.
As such, the exclusion of building improvements from the benefit of 100 percent bonus depreciation—whether accidental or not—is unjustified. Policymakers should act to ensure that qualified improvement property is eligible for 100 percent bonus depreciation; at a minimum, they should make sure that the rules for deducting the cost of building improvements do not become more restrictive than they previously were.

Overview of Expensing

Under the U.S. tax code, businesses can generally deduct their ordinary business costs when figuring their income for income tax purposes. However, this is not always the case for the costs of capital investments, such as equipment, machinery, and buildings. Typically, when businesses incur these sorts of costs, they must deduct them over several years according to depreciation schedules instead of immediately in the year the investment occurs.[1]

This system that requires businesses to deduct their capital expenditures over time rather than immediately is quite complicated and means businesses cannot fully recover the cost of those investments. The disallowed portion of cost recovery understates costs and overstates profits, which leads to greater tax burdens. The tax code increases the cost of capital, which leads to less capital investment and lower employment, output, and wages.
Full expensing, however, allows businesses to immediately deduct 100 percent of the cost of their capital expenses. Thus, it removes a bias against investment in the tax code and lowers the cost of capital, encouraging business investment.

Qualified Improvement Property

Prior to the Tax Cuts and Jobs Act, the tax code categorized certain interior building improvements into different classes:

• qualified leasehold improvement property,
• qualified restaurant property
• qualified retail improvement property.

Under prior law, assets with lives of 20 years or less were eligible for 50 percent bonus depreciation. While most building improvements are generally depreciable over 39 years, improvements meeting these category definitions were eligible for a 15-year cost recovery period and thus eligible for 50 percent bonus depreciation under old law.[2]
Improvement property generally includes interior improvements made in buildings that are nonresidential real property.
> If a business invested in new lighting, exit signs, or woodwork, these investments would generally be categorized as improvement property.
> Or consider a restaurant or retail store, perhaps with lots of foot traffic, and as a result it needs new permanent floor coverings; such an investment would also generally be qualified improvement property.
The definition excludes improvements made to enlarge a building, for an elevator or escalator, or to the internal structural framework of a building.[3]
The PATH Act of 2015 created a fourth category, qualified improvement property (QIP), to extend bonus depreciation to additional improvements to building interiors.[4]
Under this new definition, unlike the other three types of improvement property, eligibility did not require that QIP investments be made under a lease.
It also did not require a three-year lag between when the building was first placed in service and when the improvement property was placed in service.
A notable feature of QIP, however, was that it did not have a cost recovery period of 15 years; for QIP to be recovered over a 15-year period, it had to also meet the definition of one of the other three types of improvement property.[5]
This means that in some instances, QIP may have qualified for bonus depreciation, but the remaining basis would have been depreciated over a 39-year period.
This created complexity across different categories and definitions of improvement property.