A Simple Fix to the “Retail Glitch”

Luke Richardson, CPA, MAcc, and John McKinley, CPA, CGMA, JD, LLM
Published Date:
Jul 1, 2020

With the recent passage of the Coronavirus Aid, Relief, and Economic Security (CARES) Act, Congress enacted many tax provisions intended to lessen the economic harm caused by the coronavirus (COVID-19) outbreak. Among those changes was a fix for an issue known as the “retail glitch,” which arose from the last major piece of tax legislation, the Tax Cuts and Jobs Act (TCJA). This retail glitch was created by an inadvertent drafting error that made certain “qualified improvement property” ineligible for additional first-year depreciation—that is, bonus deprecation—under IRC section 168(k).


The drafting error occurred when Congress, as part of the TCJA, consolidated four different categories of qualified property, each created through various legislative acts, into one sweeping category termed “qualified improvement property” [IRC section 168(e)(6)]. These categories were “qualified leasehold improvement property,” “qualified restaurant property,” “qualified retail improvement property,” and “qualified improvement property.” (For more information, see this report by the Congressional Research Service.)

Prior to this consolidation, most assets in these four categories independently met the statutory definition of 15-year property, making such property eligible for bonus depreciation. In its haste to enact the TCJA, however, Congress neglected to assign a 15-year recovery period to “qualified improvement property” after striking the aforementioned other types of qualified property. Because otherwise qualifying improvement property needs to have a useful life of “20 years or less” per IRC section 168(k)(2)(A)(i)(I) in order to be eligible for bonus depreciation, assets placed in the newly fashioned qualified improvement property category were apparently now ineligible.

Congress has repeatedly tried to fix the glitch since the unfortunate effect of its drafting error became known. The most recent attempt in January 2019 would have patched the problem as part of the TCJA, but the bill did not receive the requisite number of votes in the House to pass.

Evidently, correcting the oversight would require nothing short of a devastating healthcare crisis. What follows is a brief discussion of how the CARES Act fixed the glitch and what it means for taxpayers going forward.

Qualified Improvement Property

When the TCJA consolidated the various areas of qualified property into one category, it continued to define qualified improvement property as any improvement to the interior portion of nonresidential property, “if such improvement was placed in service after the date the building was first placed in service” [IRC section 168(e)(6)(A); Treasury Regulations section 1.167(a)-10(b)]. “Placed in service” usually refers to when the property is ready for operational use, not when the property is bought. To illustrate, if a calendar-year taxpayer purchases a building on Dec. 31, 2019, but does not place the building into operational use until Jan. 2, 2020, depreciation is calculated beginning in 2020.

There are a few exceptions to what constitutes qualified improvement property. Specifically, improvements that result in an enlargement of the building, improvements involving an escalator or elevator, or any improvements to the “internal structural framework” of the building are not considered qualified improvement property, according to IRC section 168(e)(6)(B)(i)-(iii).

The Retail Glitch

The retail glitch arose not from consolidation of the four categories of qualified property under IRC section 168(e)(6), but from the lack of an IRC provision assigning a 15-year class life to qualified improvement property in the wake of the TCJA.

Under the Protecting Americans from Tax Hikes (PATH) Act and previous legislation, qualified leasehold improvement property (QLIP), qualified restaurant property (QRP), qualified retail improvement property (QRIP), and certain qualified improvement property were eligible for bonus depreciation. IRC section 168(e)(3)(E) assigned a useful life of 15 years to QLIP, QRP, and QRIP, and IRC section 168(k)(2)(A) defined qualified property eligible for bonus depreciation to include qualified improvement property not otherwise assigned a 39-year class life.

However, when the TCJA consolidated the QLIP, QRP, QRIP, and qualified improvement property categories into a single qualified improvement property category under IRC section 168(e)(6)—retaining the definition of qualified improvement property—it did not assign a useful life of 20 years or less. As a result, qualified improvement property was generally subject to a 39-year useful life as nonresidential real property and, therefore, no longer eligible for bonus depreciation. The TCJA had thus deleted the provisions permitting bonus depreciation of qualified improvement property, but failed to adequately replace them.

In turn, taxpayers and their representatives became confused as to whether qualified improvement property could continue to be depreciated over 15 years or, since a new category for qualified improvement property was not included under IRC section 168(e)(3)(E), this new asset class would have to be depreciated over 39 years, similar to other nonresidential property [IRC section 168(e)(2)(B)]. Because qualified improvement property was not assigned a useful life of 20 years or less, it no longer appeared to meet the definition of bonus depreciation under IRC section 168(k)(2)(A)(i).

It seems quite clear that Congress intended to assign qualified improvement property a depreciable life of 15 years. The conference agreement to the House report stated that a general 15-year modified accelerated cost recovery system (MACRS) recovery period would apply for “qualified improvement property”; however, the Treasury department and the IRS saw it differently.

One commenter asked that the IRS not “challenge or audit taxpayers that treat qualified improvement property placed in service after 2017 as 15-year property eligible for the additional first year depreciation deduction.” Indeed, many commenters sought clarification on whether qualified improvement property placed in service after 2017 was eligible for bonus depreciation.

The IRS eventually determined that only Congress, through a “legislative change,” could make a change in the recovery period for qualified improvement property. As a result, the agency declined to act on any of the comments offered, signaling that qualified improvement property would be depreciated as nonresidential property under IRC section 168(e)(2)(B) and thus be ineligible for bonus depreciation.

The “Retail Fix”

In the CARES Act, Congress made three changes pertaining to qualified improvement property. Collectively known as the retail fix, these edits included—

  • changing the depreciable life for qualified improvement property to 15 years for MACRS and 20 years for the alternative depreciation system (ADS),
  • clarifying that the improvement needs to be “made by the taxpayer,” and
  • ·noting that the effective date for the new provisions is retroactive to the date the TCJA was implemented.

Change in useful life

The first and arguably most significant aspect of the retail fix was the assignment of a recovery period for qualified improvement property, now statutorily defined as 15 years for MACRS and 20 years for ADS [IRC sections 168(e)(3)(E)(vii) and 168(g)(3)(B)]. Recall that the Treasury department was unable to unilaterally make that change. Since November 1988, Congress has reserved the authority to modify the class lives of depreciable property. (For more information, consider footnote 265 in this Joint Committee on Taxation (JCT) publication: “Rev. Proc. 87-56 [enumerating recovery periods for selected asset classes], as modified by Rev. Proc. 88-22, remains in effect except to the extent that the Congress has, since 1988, statutorily modified the recovery period for certain depreciable assets, effectively superseding any administrative guidance with regard to such assets.”)

The provision of the CARES Act assigning a 15-year recovery period to qualified improvement property thereby reverses T.D. 9874 (stating that qualified improvement property does not have a recovery period of 20 years or less) with respect to claiming bonus depreciation on qualified improvement property [footnote 285 of the JCT publication].

Made by the taxpayer

The CARES Act also added a caveat to IRC section 168(e)(6)(A) that the improvement must be made by the taxpayer. To help explain the provision, the JCT document provides an example: If a taxpayer purchases a building in a “taxable transaction,” then any qualified improvements placed in service by the seller do not meet the definition of qualified improvement property with respect to the buyer.

Effective date

According to the JCT, the provisions mentioned above will be effective as if they were included in the original draft of the TCJA. As such, taxpayers who improperly depreciated qualified improvement property as 39-year MACRS property or 40-year ADS property on 2018 and/or 2019 tax returns now have a few options.

Taxpayers may wish to reclassify qualified improvement property as 15-year or 20-year property for MACRS or ADS, respectively, and elect to take bonus depreciation. Taxpayers so situated may be eligible to file an amended return, seek an administrative adjustment request under IRC section 6227, or file Form 3115. Similar procedures apply if a taxpayer wishes to make, revoke, or withdraw an election for such property under IRC section 168(g)(7) (concerning the election to use ADS), IRC section 168(k)(7) (concerning the election to opt out of bonus depreciation), or IRC section 168(k)(10) (concerning the election to use a 50-percent allowance under IRC section 168(k) for certain property placed in service during certain periods). Rev. Proc. 2020-25 provides guidance on how taxpayers may pursue these alternatives.

Note that if a taxpayer changes the depreciable life of qualified improvement property from 39 years to 15 years for MACRS and subsequently claims bonus depreciation, doing so may create a net operating loss (NOL). The CARES Act enables a five-year carryback period for NOLs arising in tax years 2018, 2019, and 2020. This may produce a potential cash flow opportunity where one did not exist before.

Next Steps

Only time will tell how many taxpayers are able to “fix” the glitch; however, in the midst of a severe economic downturn it is likely that taxpayers will welcome an influx of cash wherever possible. Fixing the glitch might just provide a timely cash flow windfall, bringing some relief to the barrage of operational challenges facing taxpayers today. In any event, taxpayers are encouraged to consult with their tax representative to determine whether they stand to benefit from this simple fix to the retail glitch.

Luke Richardson, CPA, MAcc, is an instructor of accounting and taxation at the University of South Florida. He can be reached at lericha2@usf.edu.

John McKinley, CPA, CGMA, JD, LLM, is a professor of the practice – accounting and taxation at Cornell University. He can be reached at jwm336@cornell.edu.

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