Qualified Improvement Property and Cost Segregation: The 15-Year Classification Landlords Miss
A Classification Worth 24 Years
When a landlord builds out a tenant suite, remodels a lobby, or replaces interior finishes in a commercial building, the default bookkeeping treatment is to capitalize the cost to the building. That puts it on a 39-year schedule.
In many cases that is wrong. Interior nonstructural improvements made to a nonresidential building after the building was first placed in service are qualified improvement property, defined in IRC Section 168(e)(6), and QIP carries a 15-year recovery period rather than 39.
Because 15-year property has a recovery period of 20 years or less, it is eligible for bonus depreciation under Section 168(k). With bonus at 100 percent, correctly identifying QIP can mean the difference between deducting a $500,000 buildout over 39 years and deducting all of it in year one.
The Definition and Its Exclusions
QIP is any improvement made by the taxpayer to an interior portion of a building which is nonresidential real property, if the improvement is placed in service after the date the building was first placed in service.
Three things are expressly excluded. Improvements attributable to the enlargement of the building. Elevators and escalators. And any improvement attributable to the internal structural framework of the building.
Several implications follow. QIP applies only to nonresidential property, so an apartment building renovation does not qualify. The improvement must be interior, so roof work, exterior facade, windows, and site work are outside the definition. And the building must already have been placed in service, so improvements made as part of original construction are not QIP, they are simply part of the building.
Note also that the improvement must be made by the taxpayer. If you buy a building that a previous owner improved, you have acquired a building, not QIP. The classification attaches to improvements you make.
The Retail Glitch and Why History Matters
QIP has a complicated recent history that still causes confusion. The Tax Cuts and Jobs Act intended to assign QIP a 15-year life, but a drafting error left it at 39 years and therefore ineligible for bonus depreciation. This was widely known as the retail glitch, and it meant that from 2018 through early 2020, taxpayers were required to recover QIP over 39 years.
The CARES Act corrected the error retroactively to property placed in service after 2017. Taxpayers who had capitalized QIP at 39 years during that window were permitted to change their method and recover the difference.
This history matters because it is still producing look-back opportunities. Buildings improved during that period may still be sitting on 39-year schedules if nobody revisited the classification after the fix. A Section 481(a) catch-up on Form 3115 recovers it.
QIP Versus 5-Year Property Inside the Same Buildout
A common misunderstanding is that QIP and cost segregation are alternatives. They are not. A tenant buildout contains both.
Within a $500,000 office buildout, a study might identify $150,000 of 5-year personal property, data cabling, decorative lighting, movable partitions, appliances, security systems, and the dedicated electrical serving specific equipment. Another $300,000 might be QIP: new interior walls, ceilings, general lighting, interior doors, flooring, and the HVAC distribution serving the improved space. The remaining $50,000 might be structural work or exterior scope that stays on the 39-year building.
All of the 5-year property and all of the QIP is bonus eligible, so with 100 percent bonus the first-year outcome is similar. Where the distinction becomes real is on sale. The 5-year personal property is Section 1245 property subject to full ordinary income recapture. QIP is Section 1250 property, generally receiving the more favorable unrecaptured gain treatment capped at 25 percent. Our post on depreciation recapture covers the difference.
Section 179 Reaches Things QIP Does Not
There is a fourth category worth knowing. Section 179 expensing applies to certain improvements to nonresidential real property that fall outside both QIP and personal property: roofs, HVAC units, fire protection and alarm systems, and security systems.
Those items are structural components on a 39-year life, and they are not bonus eligible. But they can be expensed under Section 179 subject to the annual limit and the taxable income limitation. For a landlord replacing a roof and an HVAC system in the same year, Section 179 is the only accelerated option available. Our post on Section 179 versus cost segregation covers how the two interact.
Because Section 179 cannot create a loss and bonus depreciation can, the ordering of these elections matters and should be modeled rather than defaulted. AE Tax Advisors addresses the interaction for commercial owners in their guide to QIP and tenant renovations.
Getting Buildouts Classified Correctly
If you own commercial property and have capitalized tenant buildouts, remodels, or interior renovations to the building over the past several years, there is a reasonable chance some of it should be sitting at 15 years instead of 39.
Stratum performs engineering-based studies that separate QIP, personal property, land improvements, and structural components within a single renovation, and provides the documentation your CPA needs for a current-year filing or a Form 3115 catch-up.
Request a free estimate or book a call with your renovation history.