recent irs guidance for qualified improvement property...

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Recent IRS Guidance for Qualified Improvement Property:

IRC Sec. 168(k) Bonus Depreciation, Form 3115

WEDNESDAY, NOVEMBER 4, 2020, 1:00-2:50 pm Eastern

FOR LIVE PROGRAM ONLY

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November 4, 2020

Recent IRS Guidance for Qualified Improvement Property: IRC Sec. 168(k) Bonus Depreciation, Form 3115

John W. Hanning, CCSP, MBA, Principal

KBKG

[email protected]

Gian P. Pazzia, CCSP, Principal

KBKG

[email protected]

Mark Zettell, PE, Tax Managing Director

BDO USA, LLP

[email protected]




Notice

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without limitation, the tax treatment or tax structure, or both, of any transaction

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any tax opinions, memoranda, or other tax analyses contained in those materials.

The information contained herein is of a general nature and based on authorities that are

subject to change. Applicability of the information to specific situations should be

determined through consultation with your tax adviser.

IRS Guidance For Qualified Improvement Property

John W. Hanning

KBKG

[email protected]

678.996.5791

Gian Pazzia

KBKG

[email protected]

626.538.3150

Mark Zettell

BDO USA, LLP

[email protected]

616-802-3458

Wednesday, November 4, 2020 1:00pm-2:50pm EST, 10:00am-11:50am PST




Course Agenda

I. Cost Segregation Overview

II. History of Qualified Property & Bonus Depreciation Rules

III. PATH Act & Tax Cuts and Jobs Act

I. Qualified Improvement Property (QIP)

II. CARES Act Considerations

III. The QIP “Fix” & Method Changes to Conform

I. Applicability of Bonus Depreciation

II. Written Binding Contract Rules & 1031 Exchanges

III. Changing prior bonus depreciation elections, depreciation

lives, and methods

6

Maximize Bonus Deductions Using Cost Segregation

• Cost segregation studies reclassify a substantial

portion of real property assets

• From tax recovery periods of 39 or 27.5 years into

asset classes that will qualify for bonus depreciation

(5, 7, 15 year property).

• Allows taxpayer to take full advantage of the bonus

rules

• Identifies every building component eligible

• Special piping and fixtures (5 or 7 years)

• Certain finish carpentry and millwork (5 or 7

years)

• Special electrical connections (5 or 7 years)

• Certain exterior land improvements (15 or 20

years) and so on…

7

Cost Segregation Buckets

8

Enhanced Cost Segregation Studies

9

Accelerated Deductions

10

$0

$100,000

$200,000

$300,000

$400,000

$500,000

2018 2023 2028 2033 2038 2043

Depreciation Expense

After Study

Before Study

Pre 2018 Depreciation Rules

Bonus Pre 2018 Specified Property Type

Under Pre 2018 Law Qualified Property includes:

• MACRS property with GDS recovery period of 20 years or less

• Water Utility Property

• Computer Software (with the exception of software covered by Section 197)

• Long Production Period Property

• QUALIFIED IMPROVEMENT PROPERTY (2017 - Beyond)

• Qualified Leasehold Improvements (2001 – 2017)

• Qualified Retail Improvement Property (only in 2016 – 2017)

• Qualified Restaurant Improvement Property (only in 2008)

12

Bonus Pre 2018 “Qualified” Real Property

• Qualified Improvement Property (QIP)

• Qualified Leasehold Improvement Property (QLI)

• Qualified Restaurant Property (QRES)

• Qualified Retail Property (QRET)

13

Bonus Pre 2018 Qualified Leasehold Improvements

• Qualified leasehold improvement property (QLI):

― Any Section 1250 property which is an improvement to non-residential

real property; and

― To interior portion of building occupied exclusively by lessee (not a

common area); and

― Placed in service more than 3 years after the building was first placed in

service by any person; and

― Made pursuant to a lease

― Lease cannot be between related parties

― See related party rules (Code Section 1504)

― 80% common ownership in both entities

― Depreciated over 15-years with SL convention, AND qualifies for bonus

14

Bonus Pre 2018 Qualified Leasehold Improvements - Exclusions

Qualified leasehold property does NOT include:

• Costs for the enlargement of a building,

• Elevators, escalators

• The internal structural framework of a building

• Structural components that benefit a common area

Many taxpayers make the mistake of claiming bonus on all Tenant

Improvement/Leasehold Improvement costs assuming they are all for QLI

• Roofing, Concrete, Steel, Windows, Storefront, Masonry, Finishes, EIFS,

Seismic Retrofitting, Thermal & Moisture Protection, Elevators, Lobby Area,

Hallways, Bathrooms

15

Bonus Pre 2018 Qualified Restaurant Property

Restaurant Property

• Available through 2017

• 15-year recovery, no bonus

Definition of QREST Property:

• Any 1250 property that is a

building or an improvement to the

building,

• At least 50% of the building’s

square footage is devoted to the

preparation of, and seating for on-

premises consumption of,

prepared meals.

16

Bonus Pre 2018 Qualified Retail Improvements

Qualified Retail Property

• Similar to Restaurant, 15-year recovery through 2017

• Any improvement to an interior portion of a building which is nonresidential

real property if

― such portion is open to the general public and is used in the retail trade

or business of selling tangible personal property to the general public,

and

― such improvement is placed in service more than 3 years after the date

the building was first placed in service.

• QRET shall not include any improvement for which the expenditure is

attributable to— (i) the enlargement of the building, (ii) any elevator or

escalator, (iii) any structural component benefitting a common area, or (iv)

the internal structural framework of the building.

17

PATH Act - Qualified Improvement Property

Qualified Improvement Property is defined as:

• Sec. 1250 interior improvements to a non-residential property,

• “Made by the taxpayer” after the building was originally placed in service,

• Non-structural in nature,

• Not an elevator or an escalator,

• Not an expansion of the building

18

PATH Act - Qualified Improvement Property

Qualified Improvement Property (QIP)

• Interior lighting

• Flooring

• Interior walls

• Plumbing

• Electrical wiring

• And more

19

QIP is NOT

• Seismic retrofitting

• Storefronts

• Windows

• Rooftop HVAC Units

• Elevator/Escalators

• Expansion costs

• Loading Dock Doors

• Roofing

Tax Reform – Bonus Depreciation

Original Use guidance remains essentially the same as prior guidance under 1.168(k)

• General Bonus Depreciation Requirements:

― Must be property of a specified type

― Original use of the property must commence with the taxpayer or if used

depreciable property must meet certain acquisition requirements

― Must be placed in service by the taxpayer within the specific time period

― Must be acquired by the taxpayer after 9/27/17

― If acquired before 9/28/17 – property is subject to old bonus rules

Bonus on new AND USED PROPERTY starting in 2018

• Qualified property definition was expanded to include both new and used property.

20


Property of a Specified Type

• MACRS property with a recovery period of 20 years or less

• Certain computer software

• Water utility property

• Newly added “Qualified Film or Television Production Property”

• Newly added “Qualified Live Theatrical Production Property”

Property types removed post 12/31/2017

• Qualified Leasehold Improvement Property – NO LONGER 15 YEAR PROPERTY

• Qualified Restaurant Property – NO LONGER 15 YEAR PROPERTY

• Qualified Retail Property – NO LONGER 15 YEAR PROPERTY

21

History of Bonus Depreciation

22

Content Slide – Photos/Charts

23

Download this helpful chart at: https://www.kbkg.com/resources

Polling Question #1

CARES ACT Changes

Qualified Improvement Property history:

26

39yr w/ Bonus 39yr w/o Bonus 15yr w/ Bonus

1/1/2016 to 12/31/2017 – QIP 39-yr, 50% bonus eligible

9/27/2017 to 12/31/2017 – QIP 39-yr, 100% bonus eligible (if acquired & PIS during period)

1/1/2018 to 12/31/2019 – QIP 39-yr, not bonus eligible (AS PER TCJA)

1/1/2018 to 12/31/2022 – QIP 15-yr, 100% bonus eligible (CORRECTED AS PER CARES ACT)

Qualified Improvement Property technical correction “Retail Glitch”

• 15-year class life, 100% bonus eligible

CARES ACT Changes

Qualified Improvement Property & CARES Act Considerations

• MACRS tax classification

― 39-year to 15-year GDS recovery period

― 40-year to 20-year ADS recovery period

• Added clarifying language “Made by the taxpayer”

― Taxpayer classifying and depreciating property as QIP, must have

completed the improvements

• State tax conformity varies

― Many states do not conform to Federal bonus depreciation rules

― Certain states do not conform to Federal 15yr MACRS tax life

• Sec. 163(j) election out of business interest expense limitation

27

CARES ACT Changes


• Taxpayers permitted to file amend return, administrative adjustment request

or accounting method change Form 3115 to correct depreciation

• Revenue Procedure 2020-25

― DCN #244 – “QIP fix”

― Reduced filing requirement

― Bypasses certain scope limitations of DCN #7

― DCN #245 – “Election fix”

― Limited time to change or revoke elections for ADS, electing out of

bonus and electing 50% vs. 100% bonus on assets acquired in 2017


― Revocation of Sec. 163(j) election

28

CARES ACT Changes


• Taxpayers permitted to file amended return, administrative adjustment

request (AAR), or accounting method change Form 3115 to correct

depreciation


― The QIP “Fix”

― Taxpayers with QIP in 2018 and/or 2019 that filed their returns treating

the assets as bonus ineligible 39-year property can amend return(s) to

claim additional depreciation

― Alternatively, taxpayers may file an automatic Form 3115 (DCN #244)

with their 2020 return to claim the missed depreciation as a favorable

Section 481(a) adjustment

― Note - continuing to treat QIP as 39-year property is an impermissible

method of accounting and the IRS expects the change to be made

29

CARES ACT Changes

Qualified Improvement Property - EXAMPLE

• Taxpayer acquires a commercial retail building in June 2019 for

$2M. The building was originally constructed in 2010. Revenue

Procedure 2020-25

• Taxpayer spends $1M in 2020 on a renovation improvement

project that includes:

― $100k for rooftop HVAC units, $50k for new windows,

$30k for interior seismic upgrades (39yr structural real

property, no bonus)

― $70k for interior HVAC ductwork, $200k for new

electric switches/outlet/lights, $100k for new

bathroom plumbing, $250k for drywall, flooring and

other interior finishes(15yr QIP, 100% bonus)

― $150k for decorative finishes, trade fixtures and

millwork (5yr personal property, 100% bonus)

― $50k for exterior site improvements (15yr land

improvement property, 100% bonus)

30

CARES ACT Changes

Qualified Improvement Property - EXAMPLE

• Revenue Procedure 2017-33 – Sec. 4.02(5)(d) Example 4

― Taxpayer A begins construction of a multi-tenant office building in March 2019

― Taxpayer B enters into a lease for one floor of the building in December of 2019 and

will construct and own tenant improvements

― Taxpayer A receives certificate of occupancy for core and shell building in February

2020 and places the building in service

― Taxpayer B places completed tenant improvements in service in June 2020

― Because Taxpayer B’s tenant improvements were placed in service after Taxpayer

A’s building was placed in service, these improvements are QIP

31

Food Products

Manufacturing

• Extensive $16.7 million renovation of

existing facility in 2019

• $5.4 million in QIP

Strip Center

Restaurants

• Seven leasehold locations in 2019

• $7.3 million in construction

• Four locations in existing buildings (QIP)

Benefits

Increased Depreciation – Year 1 (100% bonus) $4,072,000

Increased Cash Flow – Year 1 (37.0% fed. rate) 1,506,000

NPV of Increased Cash Flow (6%, 39 years) 923,000

Benefits

Increased Depreciation – Year 1 (100% bonus) $12,725,000

Increased Cash Flow – Year 1 (21.0% fed. rate) 2,672,000

NPV of Increased Cash Flow (6%, 39 years) 1,640,000

The QIP “Fix” – Success Stories in 2019

32

Polling Question #2


New IRC Reg Section 1.168(k)-2 for property acquired and placed in service after 9/27/17

• Proposed regulations issued Aug 2018 (REG-104397-18)

• Final regulations issued Sept 2019 (T.D. 9874)

― Written Binding Contract Rules

― Used Property

― Situations Where using ADS does not Prevent Bonus Deduction

• Additional proposed regulations issued Sept 2019 (REG106808-19)

― Business Floor Plan Financing

― Used Property – 5 year look back

― Written Binding Contract – No contracts & Purchase entities

― Component Election

IRC Reg Section 1.168(k)-1 generally remains applicable for property acquired and placed in

service prior to 9/28/17

34


CARES Act released on 3/27/2020

• Net Operating Loss carryback provisions

― 2018, 2019, or 2020 losses can be carried back five years

― NOL limit of 80% Adjusted Taxable Income suspended to fully offset income

• Net interest deduction limitation

― Temporary increase of business interest expense for 2019 and 2020

― Increase from 30% ATI to 50% ATI

35


100% bonus depreciation is applicable for assets acquired and placed in service after

9/27/17 and prior to 1/1/23

• There is an additional year to place in service long production period property

(LPPP) and certain aircraft

― Long Production Period Property (LPPP) is property:

― With a recovery period of at least 10 years or is transportation property

― Subject to 263A

― With an estimated production period exceeding 1 year and production cost

exceeding $1M

― Must meet acquired and PISD rules

― Bonus is now available for used property

36

0%

50%

100%

Before1/1/2024

Before1/1/2025

Before1/1/2026

Before1/1/2027

Phase down through 2026


Used Property requirements include:

• Taxpayer or predecessor cannot have had depreciable interest in the property prior to

acquisition

― Predecessor defined as:

― a transferor of an asset to a transferee in a transaction to which section 381(a) applies;

― a transferor of an asset to a transferee in a transaction in which the transferee’s basis in

the asset is determined, in whole or in part, by reference to the basis of the asset in the

hands of the transferor;

― a partnership that is considered as continuing under section 708(b)(2) and section 1.708-1;

the decedent in the case of an asset acquired by an estate; or

― a transferor of an asset to a trust.

• The property must not be acquired from a related party, a component member of a

controlled group, or in certain carryover basis transactions

― Regulations note that if a member of a consolidated group acquires property from

an unrelated group that acquired property from a different member of the

consolidated group, bonus would not be eligible.

37


Special rules for fractional interests are distinguished between two separate scenarios:

• If a taxpayer owned a depreciable interest in a portion of property and subsequently

acquires an additional depreciable interest in the same property that additional interest

is not treated as having been previously used by the taxpayer

• If a taxpayer owned a depreciable interest in a portion of a property, sells all or part of

that portion, and then subsequently acquires a different portion of the same property,

the taxpayer will be treated as having owned previously the used property up to the

amount of the portion in which it held a depreciable interest prior to the sale

“Series of related transactions” rule states:

• Property is treated as directly transferred from the original transferor to the ultimate

transferee, and

• The relationship between the original transferor and the ultimate transferee is tested

immediately after the last transaction in the series

Depreciable interest lookback rule: Lookback period of 5 years for determining whether a

taxpayer or predecessor held a depreciable interest in property.

38


Section 754 Elections – This step up can

receive the new bonus depreciation

• As long as it’s a new partner coming

in.

― Property not used by the

taxpayer before – bonus applies

Step-Up Upon Death

• Step-up on death is specifically

excluded from the new bonus

depreciation

― Property received by a decedent

– bonus depreciation NOT

applicable

39


Property of a Specified Type – SPECIFICALLY EXCLUDED from bonus

applicability

• Property required to be depreciated under the alternative depreciation

system (ADS)

― Used predominately outside of the U.S.

― Tax – exempt use property

― Tax – exempt bond financed property

** 2019 Final regs clarify when using ADS does not exclude certain taxpayers

• Property primarily used in certain public utility trades or businesses

― Applies to property acquired after 9/27/17 and placed in service in tax

years beginning on or after 1/1/18

** 2019 Final regs clarify that 100% bonus does not apply to public utility self-constructed after

9/27/17

40


• Property used in a trade or business that has floor

plan financing (e.g., automobile dealerships)

** 2019 Proposed regs clarify that taxpayers leasing

property to a trade or business with floor plan

financing indebtedness or a rate-regulated utility may

still claim bonus provide the lessor is not described in

Sec. 168(k)(9)(A) or (B) and all other requirements are

met

― Good news for lessors or real estate holding

companies that lease the property to

operating entity

** 2019 Proposed regs provide that floor plan interest is

not considered in a tax year if the sum of interest

business income and 30% of adjusted taxable income

equals or exceeds business interest as defined in Code

Sec. 163(j)(5). Tested annually

41

Polling Question #3


Placed in Service Requirements

• In order to qualify for 100% bonus depreciation,

the property must be placed in service after

9/27/17 and before 1/1/23 (except for LPPP, which

is 1/1/24).

— New regulations are generally the same as

existing placed in-service rules outlined in

1.168(k)-1(b)(5)

― For new construction buildings, we

generally look to the date the certificate

of occupancy was issued

― For acquired property, we look to the

“ready and available” standard

• Regulations contain specific rules for qualified

film or television productions and qualified

live theatrical productions

44


Acquisition Requirements

Used property – Acquired existing property

• Property will be treated as “acquired” as

of the later date of the following:

— the date on which the contract is

entered;

— the date on which the contract is

enforceable under state law;

— If the contract has one or more

cancellation periods, the date on

which all cancellation periods end; or

— if the contract has one or more

contingency clauses, the date on

which all conditions subject to such

clauses are satisfied.

45


Acquisition Requirements (Continued)

New property – Self constructed property (by a 3rd Party)

• Property that is manufactured, constructed, or produced for the taxpayer by

a 3rd party under a written binding contract is treated as acquired pursuant

to the binding contract

New property – Self constructed property (by a 3rd Party)

• Property is acquired when the taxpayer begins manufacturing, constructing, or

producing the property

• Optional safe harbor permits a taxpayer to determine the acquisition date as the

date on which more than 10% of total construction cost has been incurred

(“physical work of a significant nature” completed)

― Soft costs such as architectural, engineering, design fees are not considered

in the safe harbor test

46


SEPT 2019 PROPOSED REGULATIONS

• Special Component Election

― Claim 100% bonus on components acquired or self-constructed AFTER September

27, 2017

― If part of larger property/component where deemed acquisition BEFORE September

28, 2017

― The larger property/component must be eligible for bonus depreciation at the 50%

rate

― !! This is a significant change !! Taxpayers were advised to follow bonus provisions

under the PATH Act for property acquired before Sept 28, 2017, regardless of PIS

date

― 50% Bonus in 2017

― 40% Bonus in 2018

― 30% Bonus in 2019

― 0% Bonus in 2020

― Election statement attached with timely filed return

47


SEPT 2019 PROPOSED REGULATIONS

Special Component Election – Example #2 as provided in the Federal Register

• BD is a calendar-year taxpayer

• BD enters into written binding contract with CE to manufacture a locomotive in August

2017

• Before Sept 28, 2017 BD incurs $500,000 of construction expense (more than 10% of total)

• After Sept 27, 2017 BD incurs $4M of construction expense for components of the

locomotive

― These components were acquired or self-constructed after Sept 27, 2017

• BD accepts delivery and places-in-service the complete $4.5M locomotive in Feb 2019

• BD files a component election statement with their 2019 timely filed return

Because BD incurred more than 10% of total construction cost before 9/28/17, physical work

of significant nature began before 9/28/17. Because BD made the proper component election

the $4M costs for locomotive components constructed after 9/27/17 qualify for 100% bonus.

The remaining $500k costs for locomotive components constructed before 9/28/17 qualify for

40% bonus.

48


Written Binding Contract Rules – SEPT 2019 FINAL REGULATIONS

• Regulations provide detailed guidance on the definition of a binding contract in Reg.

1.168(k)(2)(A)(iii) and (k)(4)

• Substantial changes to a contract signed outside a bonus period may create an

opportunity

• Regulations retain prior binding contract definition and further clarify that a “letter of

intent” is not a binding contract.

• Liquidated damage clause. When a contract has multiple damage provisions, the final

regulations clarify that only the provision with the highest damages is taken into account

in determining whether the contract limits damages.

Planning Consideration for Acquired Property

• If you signed a WBC after construction began, look to see if any substantial changes were

made to the contract during a bonus eligible period

― Ex. Contract signed in July 2017 (50% bonus) but changes were made in 2018 (100% bonus

depreciation)

― Change Orders may constitute a significant change. See Reg. §1.168(k)-1(b)(4)(ii)(B)

49


Written Binding Contract Rules – SEPT 2019 PROPOSED REGULATIONS

Purchase of Entities

• A contract to acquire all or substantially all the assets of a trade or business or to

acquire an entity such as a corporation, a partnership, or a limited liability

company is binding if it is enforceable under State law against the parties to the

contract

• A condition outside the control of the parties, including, for example, regulatory

agency approval, will not prevent the contract from being a binding contract

• Insubstantial terms that remain to be negotiated by the parties to the contract, or

that customary conditions remain to be satisfied, do not prevent the contract from

being a binding contract.

• Proposed rule also applies to a contract for the sale of stock in a corporation that is

treated as an asset sale as a result of a deemed asset acquisition election under

Code Sec. 338

50


1031 Exchanges

• Cost segregation can still be beneficial

on both sides of a real estate exchange

We believe there are no material changes

regarding the interaction of cost

segregation and 1031 exchanges

• Committee reports suggest there is no

intent to change the nature of 1031

transactions for real estate

• Personal property from cost segregation

is considered Real Property under state

law

• Matching of 1245 property is still

required to avoid recapture

Bonus depreciation would apply to the

excess basis in the new property

51


Business Interest Expense Limitation

• Not applicable to businesses with less

than $25M in revenue (avg. last 3 years)

Electing out of Interest Limitations

• Real Property Trade or Business (defined

in Section 469(c)(7)) may elect out.

— Must use the ADS system for REAL

property

― 40-year ADS for Commercial

― 30-year ADS for Residential

Rental

― 20-year ADS for Qualified Imprv

Prop

• Bonus depreciation is not available

when ADS is mandatory.

52

Polling Question #4

John W. Hanning

KBKG

[email protected]

678.996.5791

Gian Pazzia

KBKG

[email protected]

626.538.3150

Contact Us

54

Mark Zettell

BDO USA, LLP

[email protected]

616-802-3458




recent irs guidance for qualified improvement property...

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