Author: Leon Clinton

Do you own or lease non-residential (think commercial) real property for your business or rent non-residential real property to others? 

If so, interior improvements you make to the property may be fully deductible in a single year instead of over multiple years. 

But to be deducted instantly, the improvements must fit into the category that the tax code calls “qualified improvement property” (QIP).

What Is QIP?

Ordinarily, non-residential real property is depreciated over 39 years. And so are improvements to such real property after it is placed in service.

But Congress wants to encourage business owners to improve their properties. So, starting in 2018, the Tax Cuts and Jobs Act (TCJA) established a new category of depreciable real property: QIP, which has a much shorter recovery period than regular commercial property—15 years. But even better, for tax years 2021 and 2022, QIP can qualify for that immediate 100 percent bonus depreciation deduction. 

QIP consists of improvements, other than personal property, made by the taxpayer to the interior of non-residential real property after the date the building was first placed in service. For example, QIP includes interior improvements or renovations to any of the following:

• Office building (or single offices)
• Restaurant or bar
• Store
• Strip mall
• Motel or hotel
• Warehouse
• Factory

Since QIP applies only to non-residential property, improvements to residential rental property such as an apartment building are not QIP. 

Transient Property

Airbnb and similar short-term residential rentals also qualify as non-residential property if they are rented on a transient basis—that is, over half of the rental use is by a series of tenants who occupy the unit for less than 30 days per rental. 

QIP Examples

Examples of interior improvements that can receive QIP treatment include the following:

• Drywall
• Ceilings
• Interior doors
• Modifications to tenant spaces (if the interior walls are not load-bearing)
• Fire protection
• Mechanical
• Electrical
• Plumbing
• Heating and air interior equipment and ductwork
• Security equipment

QIP does not include improvements related to the enlargement of a building, an elevator or escalator, or the internal structural framework of a building. Structural framework includes “all load-bearing internal walls and any other internal structural supports.”

Placed in Service

QIP consists only of improvements made after the building was placed in service. But for these purposes, “placed in service” means the first time the building is placed in service by any person. By reason of this rule, you can purchase an existing property that was placed in service by an owner anytime in the past, renovate it before you place it in service, and still get QIP treatment.

But you have to make the improvements. You can’t acquire a building and treat improvements made by a previous owner as QIP.

How to Deduct Qualified Improvement Property

You may deduct the cost of QIP in one of three ways:

• use first-year bonus depreciation,
• use IRC Section 179 expensing, or
• depreciate the cost over 15 years using straight-line depreciation.

As mentioned earlier, QIP placed in service in 2021 and 2022 is eligible for 100 percent bonus depreciation. That is, you can deduct the entire cost in one year, without limit. 

Starting in 2023, the tax code reduces bonus depreciation by 20 percent per year until it is completely phased out for property placed in service in 2027.

If you would like to discuss QIP, please call me on my direct line at 408-778-9651.

• By Leon Clinton
• March 15, 2022

The strategy behind creating an S corporation and then selling your home to that S corporation comes into play when

• you want to convert your home to a rental property and take advantage of the exclusions, or
• you need more time to sell the home to realize the benefits of the $250,000 exclusion ($500,000 if filing a joint return).

With this strategy, one question often comes up: “If a married couple sells their home to their S corporation to be a rental property, can the owners be the renters?”

Answer: No. In this situation, the tax code treats your S corporation as you, the individual taxpayer, and thus you would be renting from yourself, and that would produce no tax benefits.

In effect, the S corporation renting the residence to the owner of the S corporation is the same as homeowners renting their residence to themselves. It produces no tax benefits.

On the other hand, your S corporation could rent the home for use as a principal residence to your son or daughter or other related party, and the tax code would treat that rental the same as any rental to a third party.

If you would like to discuss turning your personal residence into a rental property, please don’t hesitate to call me on my direct line at 408-778-9651.

• By Leon Clinton
• March 9, 2022

As a business owner, you are obligated to collect and remit payroll taxes for your employees. But you are not required to collect and remit payroll taxes for independent contractors.

That’s why it’s important to correctly classify workers as either employees or independent contractors. 

But here’s the problem: the rules for correctly classifying workers as either employees or independent contractors are unclear and confusing. 

And what happens if you misclassify a worker as an independent contractor? Then you can find yourself owing hundreds of thousands of dollars in back employment taxes, penalties, and interest. 

But wait! If this happens to you, the safe harbor of Section 530 may provide relief.

The Section 530 safe harbor was passed by Congress as part of the Revenue Act of 1978 in response to complaints by business owners that the IRS was being too aggressive in reclassifying their workers as employees. 

The possible good news for you is that the Section 530 safe harbor prevents the IRS from retroactively reclassifying your independent contractors as employees and subjecting you to federal employment taxes, penalties, and interest. 

Reclassifications, if any, go forward only. You are not on the hook for any money as of the date of any reclassifications.

To qualify for the Section 530 safe harbor, you must meet all the following requirements:

1. You must have filed all federal tax and information returns consistent with treating the individuals as independent contractors.
2. You must show that you never treated the individuals in question, or other workers in substantially similar positions, as employees for federal employment tax purposes.
3. You must show that you had a reasonable basis for classifying the individuals as independent contractors.

You can meet the reasonable basis requirement by showing that you relied on any one of a number of authorities, including judicial precedents or administrative rulings, a prior worker classification tax audit, or industry practice.

Your classifications of workers for federal purposes do not have to match your classifications for state law purposes.

If you would like to discuss worker classifications, please don’t hesitate to call me on my direct line at 408-778-9651.

• By Leon Clinton
• March 6, 2022