The Impact of the CARES Act on Site Selection

One of the provisions of the CARES Act, passed in March, could have a significant positive impact on companies that are in growth mode and planning additional locations.  While many recognize that the correction of the ‘retail glitch’ (as many in the media call it) benefits retailers and restaurants, it can also impact other industries looking to expand. 
Qualified improvement property (QIP) was created in 2015 under the PATH Act as a class of real property that was eligible for bonus depreciation. When tax reform came to fruition in late 2017, it was supposed to enhance QIP and provide a tremendous benefit for taxpayers. Ultimately Congress did not capture the correct wording for QIP in the Tax Cuts and Jobs Act of 2017 (TCJA), leaving many taxpayers wondering when the “fix” was coming. After more than two years of waiting, the correction appeared in the CARES Act signed on March 27, 2020.
Why should you care about QIP? Let’s start by explaining when it applies and then the tax benefits.
QIP is defined in the Internal Revenue Code as “any improvement made by the taxpayer 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. It shall not include any improvement for which the expenditure is attributable to (1) the enlargement of a building, (2) any elevator or escalator, or (3) the internal structural framework of the building.” In a nutshell, QIP includes items such as drywall, ceilings, interior doors, fire protection, mechanical, electrical, flooring and plumbing. These are typically items that would be depreciated for tax purposes over 39 years. The key item in the definition of QIP is the requirement that the assets must be “placed in service after the date such building was first placed in service.” In other words, the space had to have been in use prior to the work being done (QIP does not pertain to newly constructed buildings).
As a result of the CARES Act, QIP now has a tax life of 15 years and is eligible for bonus depreciation. The TCJA set bonus depreciation for federal tax purposes at 100% for assets acquired and placed in service by December 31, 2022, with reduced amounts in years following: 80% in 2023, 60% in 2024, 40% in 2025 and 20% in 2026. Since QIP qualifies for bonus depreciation, any assets that a taxpayer places in service by December 31, 2022, that meet the definition of QIP will qualify for 100% bonus depreciation (a 100% write-off!) during the tax year the assets are placed in service.
So why does this factor into site selection? While tax should not be the driver for the best location for your business, it could be a nice tie-breaker when comparing two options for a future location. Let’s look at two hypothetical options and their results:

  • Location A is an existing building owned by a proprietor whose previous tenant went out of business. The cost for the taxpayer to build out the location is $1.5 million, of which $1.3 million pertains to interior construction.

  • Location B is a brand-new building that a proprietor constructed in hopes of attracting a business like that of the taxpayer. The cost for the taxpayer to build out the location is $1.4 million (lower cost because no demo is required) of which $1.3 million pertains to interior construction.

Location A – The $1.3 million of assets for location A that are interior in nature will qualify as QIP and will be eligible for 100% bonus depreciation with the remaining $200,000 of assets having a 39-year life. Federal depreciation expense in the tax year placed in service would be $1.3 million for the QIP plus approximately $3,000 for the first year of the 39-year assets, equaling $1,303,000.
Location B – The $1.3 million of assets for location B that are interior in nature will NOT qualify as QIP because the building was a newly constructed building with a space that was not previously in service by the taxpayer or a previous tenant. Short of performing a cost segregation study to break out a portion of the $1.4 million of total costs to short-life assets that would qualify for bonus depreciation, the depreciation on the $1.4 million of buildout would be approximately $22,000.
$1,303,000 drops to $22,000 just because of a choice to go into Location B? Correct. If location B is used, a cost segregation study is recommended to identify portions of the building that could be depreciated over a shorter life, but the results still come up significantly short of the $1,303,000 (and you have to pay for the study). It is also recommended that a taxpayer evaluate whether their state allows bonus depreciation or if an alternate calculation will be required.   
While many taxpayers will take advantage of QIP for remodeling locations that they currently occupy, QIP is also a powerful tool to use for growing companies. If a company is looking to expand in the near future, it is best to consult with a tax adviser when looking at potential options. While tax considerations should not drive the best location, as you can see from our example, there could be a significant cash flow difference based on the site you choose.
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