For the past few years, this legislation has been passed in December and has been retroactive back to January of the then-current tax year. This habit of extending expired tax provisions in December of the tax year left many taxpayers in a lurch, unable to plan well during the year due to the mystery of what if anything would be extended and then oftentimes without sufficient time to take advantage of the extended provisions once legislation was enacted.
The Protecting Americans from Tax Hikes Act of 2015 (the “PATH Act”) was enacted on December 18, 2015. Unlike typical extender legislation, the PATH Act did not just kick the can down the road for another year or two. Various provisions of the PATH Act provide certainty to taxpayers regarding what they can expect in the coming tax years. One significant item that always appeared in extender legislation was cost recovery, including the availability of bonus depreciation. Year after year, bonus depreciation was set to expire, only to be saved retroactively for another year or two. Taxpayers planning capital expenditures during the year needed to make decisions without knowing what the depreciation rules would be. The PATH Act gave certainty regarding bonus depreciation, providing for 50% bonus depreciation through 2017, 40% in 2018, and 30% in 2019. After that, bonus depreciation will no longer be available.
Prior to the PATH Act, qualified property for bonus depreciation purposes was typically machinery, equipment, other tangible property and computer software. In addition, qualified leasehold improvement property was eligible for bonus depreciation. Qualified leasehold improvement property is any improvement to the interior portion of a building that was nonresidential real estate, as long as (1) the improvement was made under or pursuant to a lease by either the lessee, sublessee or lessor of that interior portion; (2) the interior portion was to be occupied exclusively by the lessee or sublessee; (3) the improvement was placed in service more than three years after the building was originally placed in service; and (4) the improvement was a structural component of the building. Qualified leasehold improvement property does not include any expenditure attributable to: (1) the enlargement of the building; (2) an elevator or escalator; (3) any structural component benefitting a common area; or (4) the internal structural framework of the building.
The PATH Act made a change to the definition of qualified property for bonus depreciation purposes that provides a significant opportunity for property owners. A newly created category of qualified improvement property is now eligible for bonus depreciation in the year the improvement is placed in service. Qualified improvement property (“QIP”) is any improvement to the interior portion of nonresidential real property, so long as the improvement is placed in service after the date the building is first placed in service. Property that meets the definition of QIP is eligible for bonus depreciation, even though the balance of the property may need to be depreciated over 39 years. While the definition of QIP is clearly very broad from the language in the legislation, the following are specifically excluded from the definition of QIP under the PATH Act: (1) enlargement of the building; (2) an elevator or escalator; and (3) the interior structural framework of the building.
This new classification of QIP provides the opportunity for a property owner to claim bonus depreciation the year that property is placed in service. Further, it is available to owners of newly-constructed property since it only requires that the improvement is placed in service after the date that the building itself is first placed into service. Under old law, it was impossible for owners of new buildings to utilize the qualified leasehold improvement property designation due to the three-year rule.
In addition to the benefits outlined above, the new QIP classification will allow for bonus depreciation for improvements made to the common areas of buildings. Under the old law, the improvements had to be made pursuant to a lease and to the actual leased space. Common area improvements would never meet the definition of qualified leasehold improvement property. After the PATH Act, common area improvements done by the landlord may be considered QIP and would, therefore, be eligible for bonus depreciation.
Finally, the QIP classification will allow for accelerated depreciation even in situations involving related party leases. Under pre-PATH Act law, leases between related parties were not considered leases when determining whether improvements qualified as qualified leasehold improvement property. As a result, improvements made pursuant to related party leases needed to be depreciated over 39 years. After enactment of the PATH Act, the related party lease prohibition is no longer an issue. While they would still need to be depreciated over 39 years, improvements made pursuant to related party leases would be considered QIP and would be eligible for bonus depreciation.
The PATH Act added some much-needed certainty to the Internal Revenue Code, allowing taxpayers the opportunity to plan more certainly for depreciation related to future expenditures. In addition, it added a new classification of property that is eligible for bonus depreciation. These changes provide a great opportunity for property owners to maximize cost recovery related to improvements made to nonresidential real property.