Tucked away within the pages of the CARES Act is a provision that retroactively "fixes" the so-called "retail glitch" created by the 2017 tax reform legislation.
The "retail glitch" refers to an apparent oversight in the 2017 tax reform legislation that treated qualified improvement property as nonresidential real property—so that it did not qualify for the valuable bonus depreciation option. This relief now allows restaurants and retailers—some of the businesses hardest hit by the COVID-19 pandemic—to take advantage of 100% bonus depreciation on qualified improvement property through 2022. Because the relief applies retroactively, the IRS has offered these small business clients several options for taking advantage of retroactive bonus depreciation.
Before jumping in, the client should carefully consider each option in order to maximize the value of the benefit, including conducting a case-by-case analysis of the interplay between bonus depreciation, the business interest deduction rules and NOL relief.
The Retail Glitch Fix
Qualified improvement property (QIP) includes improvements made to the interior of a building, such as renovations made to a restaurant's interior. By classifying QIP as property with a 39-year recovery period, the 2017 tax reform legislation rendered this property ineligible for bonus depreciation, which is generally only available for property with a recovery period of 20 years or less.
The CARES Act provided relief for many business owners, primarily in the retail and restaurant businesses, by fixing the retail glitch to allow businesses to take advantage of 100% bonus depreciation on QIP through 2022. The CARES Act retroactively reduced the recovery period for QIP placed in service after 2017 from 39 years to 15 years. Because of this, eligible small business clients may be entitled to a refund for 2018 and 2019.
Relatedly, the IRS has also provided relief for taxpayers who elected to be treated as real property trades or businesses. These taxpayers essentially elected out of the new business interest deduction limits and, as a trade-off, opted to forgo bonus depreciation. Under Revenue Procedure 2020-22, these businesses can revoke that election in order to take advantage of the new bonus depreciation fix. The business must file an amended return, AAR or amended Form 1065 by October 15, 2021.
Partnership Options
Because of the burden caused by filing an amended return for a prior tax year, IRS Revenue Procedure 2020-25 allows taxpayers to change their depreciation method for QIP in 2018-2020 by filing for an automatic accounting method change. The IRS will treat this as though the taxpayer changed from an impermissible method of determining depreciation to a permissible method.
As a result, taxpayers can generally make, revoke or withdraw elections with respect to bonus depreciation by filing an amended tax return, AAR or Form 3115 (with the taxpayer's federal income tax return or Form 1065). Using the Form 3115 option essentially allows the client to "catch up" in the year of change, so that the taxpayer gets the added deductions in the year the change is made (2020 or 2021), rather than the year when the property was actually placed in service. Clients have until October 15, 2021 to make this filing for the 2018 tax year.
