United States

State tax review: Qualified improvement property and the CARES Act

INSIGHT ARTICLE  | 

Background

The Coronavirus Aid, Relief, and Economic Security Act (CARES Act) makes a technical correction effective Jan. 1, 2018, defining qualified improvement property (QIP) as 15-year MACRS property for federal tax purposes, making it eligible for 100% bonus depreciation and a 20-year ADS recovery period. Recall that, for tax years beginning after Dec. 31, 2015, the Protecting Americans from Tax Hikes (PATH) Act created the QIP category, and listed it as 39-year MACRS property with a special provision to subject it to bonus depreciation. Subsequently, the Tax cuts and Jobs Act (TCJA) combined several nonresidential property categories into the QIP category, and eliminated the language specifically allowing bonus depreciation for QIP. While the legislative history for the TCJA indicates that Congress intended to treat QIP as 15-year MACRS property subject to bonus depreciation, this was not reflected in the final statutory language. As a result, QIP placed in service after Dec. 31, 2017, was still classified as 39-year MACRS property, but was no longer eligible for bonus depreciation. For more information regarding the CARES act and the federal tax treatment of QIP, read CARES Act provides a fix for the retail glitch.

State conformity and QIP

Generally, state conformity to the federal tax code must be reviewed on a state-by-state basis. While some states automatically conform to changes to the Internal Revenue Code (IRC) for state income tax purposes (so-called ‘rolling conformity’ states), many others have fixed-date conformity or only conform to specifically enumerated provisions. Excluding minor nuances, such as selective conformity to specific federal provisions, states that look to the IRC effective date rather than the enactment date for conformity considerations, and fixed-date conformity states that allow taxpayers to elect into effective rolling conformity, about half of the states are rolling conformity and the other half are fixed-date.

Based on rolling conformity and applicable fixed conformity dates, the vast majority of states have conformed to the PATH Act and TCJA QIP provisions. However, there are notable exceptions. For example, California, a fixed date conformity state, generally applies the IRC as it existed on Jan. 1, 2015, and, while the state has selectively adopted some of the provisions of the PATH Act and the TCJA, the QIP provisions are not among them.  Accordingly, California requires taxpayers to adjust QIP deductions to reflect depreciation that would have been allowed prior to the PATH Act. Additionally, even with substantial conformity to the PATH Act and TCJA QIP provisions, the vast majority of states decouple from the federal bonus depreciation rules, and QIP is subject to state-specific depreciation based on the applicable MACRS or ADS recovery period.

With the enactment of the CARES Act, about half the states automatically conform to the QIP technical corrections without having to take additional legislative action. The other half of states conform to a version of the IRC in existence before the enactment of the CARES Act. These states will need to update their fixed conformity date, provide a selective modification specifically for the new QIP rules, or change their method of conformity to adopt the fix. For example, Wisconsin has already acted to adopt the QIP provisions of the CARES Act without updating the state’s conformity date. For more information regarding Wisconsin’s changes, read Wisconsin provides coronavirus tax relief through federal conformity. However, due to temporary adjournment of state legislatures, most states have not had an opportunity to address conformity to the CARES Act, impacting potential refund claims for 2018, final tax due for 2019, and estimated payments for 2020.

Takeaways

As the states continue to respond to the QIP fix throughout the year, taxpayers may need to re-evaluate state computations and re-compute both standard and bonus depreciation adjustments. Additionally, the QIP fix applies retroactively to property placed in service in 2018, possibly creating state refund opportunities. Coupled with the state complexity of bonus depreciation conformity, taxpayers must be diligent about monitoring how states conform to the QIP fix. Impacted taxpayers should speak to their state and local tax advisers for questions about state conformity and possible refund opportunities.

Businesses in every industry should consider State tax planning in response to economic distress. For more information on the coronavirus, please see RSM’s Coronavirus Resource Center which includes related and frequently updated developments and a link to sign up for RSM’s weekly Coronavirus webcast series.

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