What is Qualified Improvement Property?

Qualified Improvement Property (QIP) is an important tax category that affects how businesses handle the depreciation of certain improvements made to real estate. When used effectively, QIP can significantly boost tax strategies and enhance cash flow, making it a vital aspect for business owners and investors to consider.

QIP covers interior upgrades made to nonresidential buildings after they’ve been put into service, but it doesn’t include structural changes, building expansions, elevators, or escalators.

The importance of QIP really came to light with the 2017 Tax Cuts and Jobs Act (TCJA), although an initial drafting mistake meant it didn’t get the favorable tax treatment it deserved. Thankfully, the CARES Act in 2020 fixed this by retroactively designating QIP as 15-year property, which opened the door for 100% bonus depreciation resulting in significant tax savings.

Now, let’s dive deeper into QIP and see how businesses can make the most of its advantages.

What Qualifies as QIP?

For an improvement to qualify as QIP, it must meet several specific criteria:

1. The improvement must be made to the interior portion of a nonresidential building.

   
   

2. The improvement must be made after the date the building was first placed in service by any taxpayer.

   
   

3. The improvement must be made by the taxpayer (the owner or lessee of the interior portion).

Examples of qualifying improvements include:

✅ HVAC systems

✅ Bathroom renovations

✅ Security systems

✅ Drywall installations

✅ Fire protection systems

✅ Ceiling installations

✅ Interior plumbing fixtures and pipes

✅ Millwork and built-in cabinetry

✅ Kitchen renovations in commercial buildings

✅ Flooring installations or replacements

✅ Interior electrical wiring and lighting systems

✅ Interior wall modifications and installations

✅ Store fixtures and displays (if attached to the building)

Eligibility for Bonus Depreciation

When it comes to the perks of QIP classification, one of the standout benefits is its eligibility for bonus depreciation. Thanks to the CARES Act of 2020, QIP is classified as 15-year property under the Modified Accelerated Cost Recovery System (MACRS), which opens the door to bonus depreciation.

So, what’s the deal with bonus depreciation? It lets businesses take a big chunk of the cost of eligible business property off their taxes right in the year they start using it, instead of spreading it out over its useful life. After the Tax Cuts and Jobs Act (TCJA), businesses can enjoy 100% bonus depreciation for qualified property (including QIP) that’s put into service after September 27, 2017, and before January 1, 2023, and it very well may be back in 2025.

This accelerated depreciation schedule can create significant tax benefits for businesses making qualified improvements.

Depreciation Period for Qualified Improvement Property

When it comes to the depreciation period for Qualified Improvement Property (QIP), if a taxpayer doesn't choose or isn't eligible for bonus depreciation, the usual depreciation timeline kicks in. Thanks to the CARES Act, there's now a 15-year recovery period for QIP under the General Depreciation System (GDS), and a longer 20-year period under the Alternative Depreciation System (ADS).

Before the changes brought by the CARES Act, QIP had to be depreciated over a lengthy 39 years, which really put a damper on its tax advantages. The new 15-year recovery period is a game changer for taxpayers, making it much more beneficial.

For those using the Modified Accelerated Cost Recovery System (MACRS) to depreciate QIP over 15 years, the 150% declining balance method comes into play. This approach allows for larger deductions in the earlier years of the asset's life, giving taxpayers a nice boost right when they need it.

Important Exclusions from QIP

When it comes to Qualified Improvement Property (QIP), not every enhancement to a building makes the cut.

Exclusions you should be aware of:

1. Building Enlargements: Any upgrades that involve increasing the building's square footage are not included.

2. Elevators or Escalators: Any installations or enhancements related to elevators and escalators are excluded.

   
   

3. Internal Structural Framework: Improvements made to the building's internal structural framework, such as load-bearing walls and other essential structural components, do not qualify.

4. Residential Rental Property: Enhancements to properties primarily used for residential purposes are not considered QIP.

5. Exterior Improvements: Any modifications to the building's exterior, including facades, roofing, or landscaping, are also excluded.

Evolution from Prior Categories

QIP effectively consolidated and replaced several previous improvement categories, including:

Qualified Leasehold Improvements

Qualified Restaurant Property

Qualified Retail Improvement Property

Understanding the distinction between QIP and these previous categories is important, especially when reviewing older tax records or planning for improvements that span multiple tax years.

Strategic Tax Planning with QIP

For businesses planning renovations or improvements, QIP classification can offer significant tax advantages:

The ability to immediately deduct up to 100% of improvement costs (if eligible for bonus depreciation) can substantially reduce taxable income in the year improvements are made.

Even without bonus depreciation, the 15-year recovery period offers faster cost recovery than the standard 39-year period for commercial building improvements.

Businesses can potentially combine QIP benefits with other tax incentives, such as the Section 179 deduction, which also allows for immediate expensing of certain property improvements.

Conclusion

The Qualified Improvement Property (QIP) is a key tax classification that can really help businesses looking to enhance their commercial real estate. With options for accelerated depreciation(especially bonus depreciation) companies can enjoy significant tax savings and better cash flow. However, it’s crucial to plan carefully and keep thorough documentation to ensure that the improvements qualify for QIP and to make the most of the tax benefits available.

For businesses gearing up for major renovations or upgrades to their commercial properties, it’s a smart move to consult with a qualified tax advisor. They can help craft a strategy that maximizes the advantages of QIP classification while fitting into the larger picture of business tax planning.