If you own commercial real estate, improvements you make to the property may qualify for a tax write-off. The name for these used to be "qualified leasehold improvements", or QLIs, but a 2015 change to the tax laws rechristened them as "qualified improvement property" (QIPs). The cost of QLIs and QIPs can be written off faster than most improvements, but a 2017 law has restricted that benefit.
TL;DR (Too Long; Didn't Read)
Qualified leasehold improvements are tax-deductible changes to the insides of leased, nonresidential property. These may include upgrades or replacements for security systems, woodwork, air conditioning, electrical systems, plumbing and permanent floor coverings. A 2015 law extended the deduction to non-leased commercial property as well.
Qualified Leasehold Improvements
Qualified leasehold improvements were defined as nonstructural improvements to nonresidential property such as restaurants, strip malls or office buildings. To claim the QLI accelerated deduction, you would have to lease the building to someone with whom you had no relationship, and you couldn't claim any improvements made in the first three years.
The change from qualified leasehold improvements to qualified improvement property came with a 2015 law, and it's more than just cosmetic. Under the new law, you can claim a write-off without leasing out the building. If you own your own offices, for instance, upgrades and remodeling could qualify for the write-off.
Writing Off Depreciation
The leasehold improvements journal entry is for depreciation. This is the tax deduction that reflects assets' loss of value due to age, obsolescence, and wear and tear. You depreciate a percentage of the asset's value each year based on how tax law classes the asset.
Depreciation is a good deal, as you get to write it off and lower your taxes without actually spending any money. Normally, improvements to commercial real estate are written off slowly, over 39 years. Qualified leasehold improvements and qualified improvement property are deductible over 15 years instead, with an option for bonus depreciation the first year.
An alternative option is to claim the improvements as a Section 179 deduction, allowing you to write off some or all of the cost the first year. It's up to you and your accountant to decide whether one large write-off is better than smaller deductions over several years.
Leasehold Improvements vs. Building Improvements
Building improvements do not automatically become QLIs or qualified improvement property.
- The improvements have to be to the building interior. In some circumstances, an improvement might be only partially claimable. Interior HVAC work would be a qualified improvement but not replacing a unit on the roof.
- Elevators and escalators don't qualify.
- Structural improvements such as expanding the building or reinforcing a load-bearing wall aren't qualified improvements.
Qualified leasehold improvements can include plumbing, floor tiles, cabinets, woodworking, air conditioning, wiring and electrical fixtures, restroom partitions, doors and non-load-bearing walls.
Qualified Improvement Property Problems
Congress's big 2017 tax-reform bill made several changes to the law for quality improvement properties. Unfortunately for property owners, it took away a lot of what the 2015 bill had given them.
The bill drew up a new list of real property that qualified for the 15-year deduction period. While Congress intended to include qualified improvement property in that list, it did not actually do so. The Treasury Department says it has to enforce the law as written, so QIP owners are stuck with the 39-year, no-bonus depreciation schedule. They can still claim the Section 179 deduction.
In 2019, Rep. Jimmy Panetta introduced the Restoring Investment In Improvements Act in the House of Representatives. If and when it passes, it will restore the bonus depreciation and 15-year schedule for qualified improvement property. At present, there's no Senate companion bill, and the House bill has not emerged from committee hearings.
- Williams-Keepers: Building Improvements Now Eligible For Bonus Depreciation
- Accounting Today: Common Depreciation Missteps and Misconceptions: Qualified Leasehold Improvements
- KBKG: Tax Insight: Qualified Improvement Property (QIP) Technical Correction is Gaining Momentum
- Journal of Accountancy: New PATH for Depreciation
- WilkinGuttenplan: Tax Legislation Introduced to Correct the Drafting Error for Qualified Improvement Property
- Internal Revenue Service. "New Rules and Limitations For Depreciation and Expensing Under the Tax Cuts and Jobs Act." Accessed April 30, 2020.
Fraser Sherman has written about every aspect of business: how to start one, how to keep one in the black, the best business structure, the details of financial statements. He's also run a couple of small businesses of his own. He lives in Durham NC with his awesome wife and two wonderful dogs. His website is frasersherman.com