Qualified Improvement Property and Bonus Depreciation

A real estate owner who renovates the interior of a building—replacing HVAC systems, flooring, walls, roofing, or electrical wiring—can treat those improvements as qualified improvement property and claim 100% bonus depreciation under current US tax law, deducting the full cost immediately rather than spreading it over 15 years. This is one of the few remaining chances to accelerate depreciation deductions on real estate.

What qualifies as QIP: the building envelope distinction

The IRS draws a firm line: qualified improvement property is any interior improvement to a nonresidential real property building placed in service after 2017, except for:

• The structural components (load-bearing walls, roof, foundation).
• The building exterior (façade, exterior windows, exterior doors).
• Building systems that serve the entire structure (the main electrical panel, central boiler, main water line).
• Escalators or elevators.

What does qualify:

Interior walls, partitions, and drywall; HVAC units and ductwork serving specific rooms or zones; interior electrical outlets, lighting, and wiring; plumbing fixtures and supply lines (not the main water line); flooring (carpet, tile, hardwood); interior doors; kitchen and bathroom cabinetry; ceilings and insulation; painting and drywall finishes; fire-suppression sprinkler systems serving specific areas.

The line is tricky. Replacing a roof can qualify as QIP if it’s an interior layer (like an attic insulation upgrade), but a full roof replacement over the structural elements does not. Exterior wall insulation does not qualify. Interior wall insulation does.

In practice, a contractor’s invoice describing “roof replacement” versus “roof insulation upgrade” determines treatment. The distinction is deliberate: Congress wanted to encourage capital investment in the interior quality and functionality of buildings while excluding major structural renovations.

Bonus depreciation: 100% immediate deduction

Prior to 2017, improvements to real estate buildings depreciated over 39 years (for nonresidential buildings) or 27.5 years (for residential). A $1 million renovation meant roughly $25,000 in annual deductions for 39 years—useful but slow.

The Tax Cuts and Jobs Act of 2017 introduced bonus depreciation for QIP. Under current law (through 2026), qualifying interior improvements can be deducted at 100% in the year they are placed in service. A $1 million renovation yields a $1 million deduction in year one.

The phase-down schedule (relevant for future years):

• 2023–2026: 100% bonus
• 2027: 80%
• 2028: 60%
• 2029: 40%
• 2030: 20%
• 2031 and later: 0% (reverts to regular 15-year depreciation)

This phase-down is automatic; Congress would have to pass new legislation to extend bonus depreciation. For owners planning major renovations, the 2023–2026 window is critical.

Mechanics: how to claim the deduction

To claim QIP bonus depreciation:

1. Establish the asset is QIP

Document that the improvement is interior (not structural), that it serves a specific area or system (not the whole building), and that it was placed in service after 2017. Contractor invoices and architectural plans help. The burden is on you to classify correctly; the IRS audits QIP treatment closely.

2. Calculate the basis

The cost basis is the capital cost to acquire and install the improvement. It includes:

• Materials and labor.
• Design and engineering.
• Permits.
• Overhead directly allocable to the project.

It excludes routine repairs, maintenance, or land costs.

3. Claim on your tax return

Use Form 4562 (Depreciation and Amortization) to report the property and claim bonus depreciation. Attach Form 8949 (Sales of Capital Assets) if required. For partnerships or S-corps, the depreciation flows through to the owners’ Schedule in their personal tax returns.

4. Consider Section 179 and cost segregation

Section 179 allows expensing of tangible personal property (e.g., appliances, trade fixtures) up to an annual limit. Some items that might be classified as QIP can instead be claimed under Section 179 if that’s more favorable.

Cost segregation studies are professional analyses that break a building project into component parts, each assigned its own depreciation life. A cost seg study might reclassify parts of the improvement as personal property (5–7 year life) rather than QIP (15-year life), accelerating deductions further. This is common for large commercial renovations.

Real-world example: office building renovation

A developer owns a 50,000 sq-ft office building. She spends $5 million on interior renovations: new HVAC (zone-based, not building-wide), new electrical and lighting, new flooring, new interior walls creating open-plan offices, new plumbing for break rooms.

QIP determination:

• New zone HVAC: qualifies (not a main system).
• Electrical and lighting: qualify (interior systems).
• Flooring: qualifies (interior improvement).
• Interior walls: qualify.
• Plumbing for break rooms: qualifies (not main water line).

Total QIP basis: $5 million.

Tax impact (2024):

• Without bonus: $5 million ÷ 15 years = $333,333 annual depreciation.
• With 100% bonus: $5 million deduction in year one.

If the developer is in the 37% federal bracket and a 10% state bracket (total 47%), the deduction is worth $2.35 million in tax savings in year one rather than spread over 15 years.

Common pitfalls and disputes

1. Misclassifying structural improvements

Replacing a roof’s structural frame is not QIP. Replacing shingles or adding insulation inside the attic might be. The distinction is subtle and audited frequently. Keep detailed invoices and plans.

2. Confusing QIP with Section 179

Section 179 applies to tangible personal property: machinery, equipment, vehicles. QIP is interior real property improvements. They don’t overlap, but some items (e.g., a built-in kitchen system) can be borderline. Professional guidance is worth the cost for large projects.

3. Over-claiming on mixed-use buildings

If a building is part-residential and part-commercial, QIP rules apply only to the nonresidential portion. Residential buildings (apartments, hotels, dormitories) do not qualify for QIP bonus depreciation. Allocating costs between residential and commercial correctly is critical and often audited.

4. Missing the “placed in service” date

Bonus depreciation applies to property placed in service in the year claimed. If you begin a project in 2025 but finish and place it in service in 2026, you claim the deduction in 2026. Early in the phase-down window, placement timing matters.

5. Repair versus improvement

Routine maintenance, repairs, and restorations do not qualify for capitalization or depreciation. Replacing a few drywall sections is a repair. Renovating an entire office floor is an improvement. The IRS looks at the scope and nature of the work. When in doubt, consult a tax professional.

Strategic considerations

Bonus depreciation is a timing benefit, not a permanent benefit. It accelerates deductions into the present, reducing your taxable income now and deferring it later (or avoiding it if you have losses to shelter). It doesn’t change the fundamental depreciable life of the asset.

For owners with low tax brackets or significant losses, the benefit is diminished. For those in high brackets, especially in high-income states, the immediate deduction is valuable.

Bonus depreciation also interacts with depreciation recapture. When you sell the property, a portion of the depreciation claimed (including bonus depreciation) is recaptured and taxed at 25% federal rate. For a buy-and-hold real estate owner, this recapture is a distant concern. For those planning to sell within a few years, the benefit of an immediate deduction is reduced by the certainty of recapture later.

See also