Qualified Improvement Property (QIP) offers a strategic opportunity to reduce your tax burden through accelerated depreciation. QIP refers to improvements made to the interior of a nonresidential building after it has been placed in service. The improvements must not include enlargements, elevators, escalators, or changes to the building’s internal structural framework. This classification was simplified under the Tax Cuts and Jobs Act (TCJA) of 2017, consolidating previous categories such as Qualified Leasehold Improvement Property (QLIP), Qualified Restaurant Property (QRP), and Qualified Retail Improvement Property (QRIP).
The CARES Act of 2020 corrected a drafting error from the TCJA, establishing a 15-year recovery period for QIP. This change made QIP eligible for 100% bonus depreciation, as its class life is under 20 years. This means you can fully depreciate the cost of QIP in the year the improvements are made, significantly reducing your taxable income.
Imagine you own a commercial building and decide to renovate the interior, spending $500,000 on improvements that qualify as QIP. With the 15-year recovery period and eligibility for 100% bonus depreciation, you can deduct the entire $500,000 in the year of the renovation. Assuming a 37% federal tax rate, this deduction could save you $185,000 in taxes.
A cost segregation study is essential for maximizing the benefits of QIP.
If you elect to be treated as a real property trade or business under IRC §163(j), you must use the Alternative Depreciation System (ADS) for QIP, which disallows bonus depreciation.
Some states do not conform to federal bonus depreciation rules, which may affect your state tax liability. For example, California does not conform to federal bonus depreciation, meaning you would not receive the same immediate tax benefit at the state level.
To ensure compliance, refer to IRS guidelines on cost segregation and QIP classification. The IRS Cost Segregation Audit Techniques Guide provides detailed instructions for conducting a study. Additionally, IRS Pub. 946, “How to Depreciate Property” offers insights into depreciation rules.