Bar / Restaurant Industry & IRS Depreciation Changes
CARES Act rules may offer depreciation / tax refund relief
Bars and restaurants have been hit hard by the COVID-19 pandemic – if not closed for business, most are operating in a limited capacity with cuts to hours, menus, number of patrons. The federal CARES Act of 2020 has made the depreciation rules more favorable by creating possible tax savings for bars and restaurants that may help these businesses during these uncertain times. This article gives a brief history on how depreciation has impacted the food service industry and how these new rules may benefit your business.
So the background …
Modified Accelerated Cost Recovery System Act 1993-2015
Historically, there were minimal changes to what was allowable depreciation on improvements to nonresidential real property. The Internal Revenue Service required these items to be depreciated over 39 years. But this is no longer true – there have been many updates to the qualified leasehold improvements (QLHI) and qualified improvement property (QIP).
Protecting Americans from Tax Hikes Act 2015
The PATH Act for tax years beginning January 1, 2016, created and extended the depreciable lives and bonus eligibility for certain types of property. The 15-year recovery period for qualified leasehold improvement property (QLHI) was made permanent and remained eligible for bonus depreciation between 2016-2019.
Qualified restaurant property 15-year depreciable life was permanently extended, but this type of property was not eligible for bonus depreciation unless the property could meet the definition of being QLHI property. Qualified retail improvement property were improvements to an interior portion of the building. These types of improvements were eligible for bonus depreciation because qualified retail improvements fell under the newly created qualified improvement property definition.
Qualified improvement property was defined as “any improvement to an interior portion of a building which is nonresidential real property if such improvement is placed in service after the date such building was first placed in service.” Certain types of improvements were specifically excluded from QIP, such as:
- Enlargement of the building
- Elevator or escalator
- Changes to internal structural framework of the building
QIP enhanced on the asset classifications that came before it in two ways:
- The property did not have to be subject to a lease between unrelated parties to be eligible.
- There was only a one-day waiting period for property to be considered QIP, as opposed to a three-year waiting period under the previous rules.
This new property type was assigned a 39-year depreciable life and made eligible for bonus depreciation.
Tax Cuts and Jobs Act 2017
On December 22, 2017, the Tax Cuts and Jobs Act was signed into law. The TCJA eliminated the separate asset categories for qualified leasehold improvements, qualified restaurant property, and qualified retail improvement property – effectively lumping all these separate classes into one QIP category. However, due to an apparent drafting error, legislators unintentionally excluded QIP from bonus depreciation eligibility.
As a result of the repeal of separate classifications for retail and restaurant property and the removal of QIP from bonus depreciation eligibility, many taxpayers were seemingly shut out from being able to claim 100% bonus depreciation. This is commonly referred to as “the retail glitch” and the food / beverage industry was impacted.
The TCJA added QIP as a category of property under Section 179 that is eligible for immediate deduction. Taxpayers can elect to include QIP costs in its Section 179 deduction calculation. Therefore, even though there was no bonus depreciation eligibility for QIP, there was still an opportunity to deduct costs related to QIP for some taxpayers. However, the taxpayers subject to section 179 limitations were limited on how much QIP they could immediately expense. This ultimately left some taxpayers ineligible for this tax break that would have been possible without the retail glitch.
… And today:
Coronavirus Aid, Relief, and Economic Security Act 2020
On March 27, 2020, the CARES Act was signed into law. It included two significant changes to Section 168 of the Internal Revenue Code that can impact and potentially help taxpayer business owners in the food and beverage industry.
- Qualified improvement property was specifically assigned a 15-year recovery period thus rendering QIP eligible for bonus depreciation.
- The definition of qualified improvement property was modified to only include improvements “made by the taxpayer.” As a result, it can be inferred that improvements to a nonresidential building acquired by a taxpayer, after having been previously placed in service by another taxpayer, will not meet the modified definition of QIP, even if all other criteria are met.
It is no wonder with all the confusion around the depreciation rules for QLHI and QIP that taxpayers have lost out on depreciation deductions and have erroneously taken depreciation under the older rules.
So, how can you take advantage of the new law changes?
The changes created by the CARES Act are effective retroactively as of September 27, 2017. Taxpayers should consider evaluating whether any previous or upcoming capital projects – such as lighting upgrades, remodeling your bar or dining space, other interior changes – may now be eligible for more favorable tax treatment. While specific procedural guidance is expected, taxpayers generally have the following options for claiming prior-year depreciation:
- File amended returns for affected prior years to capture the appropriate amount of depreciation deductions in the applicable year. (Partnerships that consider amending prior returns will need to account for the administrative adjustment request or AAR rules.)
- File superseding returns based on when QIP was placed in service and when the applicable return(s) were originally filed.
- File a Form 3115, Application for Change in Accounting Method, to “catch up” on depreciation deductions that should’ve been captured in previous years.
Depreciation rules are technical and dry reading, but they can have big impacts on tax, your tax.
These depreciation changes could result in tax refunds for qualifying businesses – which would increase the company’s cashflow to help during these difficult times. Contact your JCCS tax professional to determine if these options are best suited to your tax situation.
* This article is not a complete listing of all the details related to this tax topic and you should contact your CPA for a more detailed discussion regarding these items and how they may apply to your specific situation.
PHOTO: Dan Burton, unsplash.com
