The CARES Act Fixed A 'Typo' In 2017 Tax Law, Resulting In A Big Win For Property Owners

Tucked away in the $2 trillion stimulus bill passed by Congress a week ago is a tax law change that will benefit commercial property owners and some tenants well after the coronavirus pandemic runs its course.

The change, on page 211 of the 883-page Coronavirus Aid, Relief and Economic Security Act, expands the tax deduction for many kinds of property improvements to 100% of the cost, with the deduction applicable right away, not over many years.

Under the tax code as it stood, most interior property improvements, including tenant improvements — which the government calls qualified improvement property, or QIP — could be written off only over a period of 39 years. That wasn't the intention of Congress, but that is how it was for more than two years, according to tax experts.

"It was literally because of a typo in the 2017 tax act," Pillsbury Winthrop Shaw Pittman Tax Partner Peter Elias said. Pillsbury is an international law firm with practices in real estate and construction, as well as technology and media, energy and financial services. 

"Before that, certain types of business equipment was eligible for a 50% deduction, as opposed to being depreciated over time," Elias said.

Besides business equipment, the 50% rule applied to a variety of building improvements, Elias said, such as tenant improvements in office buildings and retail space, including restaurants. Improvements to residential properties, however, weren't covered by the old rules, so they never counted as QIP and still don't.

The 2017 Tax Cut and Jobs Act intended to enhance the tax benefit for QIP by upping the deduction from 50% of the cost of improvements to 100%, Elias said, and to expand the types of improvements covered.

"So the drafters of the bill monkeyed around with the language, but in the process of doing that, they forgot to include building improvements at all," Elias said. "Meaning not only didn't they qualify for a 100% deduction, they didn't qualify for 50% deduction they got before."

Instead, older rules kicked in, meaning a 39-year period for depreciation, Elias said, which isn't much of an incentive for real estate owners to do interior work. 

The Tax Foundation, a think tank focused on tax issues, calculated the difference for a hypothetical $100 capital investment, assuming 2% inflation and a 21% corporate tax rate, which was specified by the 2017 law.

As the law stood with its typo, a business could ultimately deduct $42.12 from its revenue, not the total $100 cost, over the life of the asset (in the case of real estate, the interior improvement), according to the foundation. The remainder, or $57.88, doesn't count as a business cost for tax purposes.

"Due to this mistreatment of capital investment, businesses pay taxes on income that does not exists," the foundation notes. Specifically, $100 in capital expenditure ultimately adds $12.15 in taxes.

That kind of error didn't take long for real estate trade organizations to notice, and so they began a campaign to fix the language. The National Retail Federation chimed in, as did the National Restaurant Association and the Real Estate Roundtable.

In October 2018, a survey by the National Association for Business Economics found that most services sector companies (two-thirds) hadn't changed their level of capital spending after the tax reform law had passed. That hesitancy was partly attributable to retailers and restaurateurs putting off new investment until the erroneous provision was fixed, the Hill reported.

"This very large difference in the after-tax cost of making these improvements is causing a delay in store and restaurant remodeling projects, as well as causing retailers to decline opportunities to purchase or lease new store locations that would require substantial improvements," the National Retail Federation wrote in a letter to the House of Representatives in March 2019.

But fixing even the smallest error in a law can be a herculean task. Efforts were made in Congress, with both Republican and Democratic sponsors, to correct the mistake. In early 2019, the Restoring Investment in Improvements Act was introduced in the House and Senate, with a goal of fixing the mistake, but it never wound up advancing. 

As recently as January, Accounting Today bemoaned the fact that no correction had been made because of congressional gridlock.

"As often happens, political gridlock got in the way," Elias said. "This wasn't the only typo in the bill, and Democrats were mostly unwilling to allow fixes on a bill entirely championed by Republicans. That isn't anything new on Capitol Hill. Republicans were mostly unwilling to allow fixes to the Affordable Care Act for the same reason." 

It took the pandemic emergency, as the retail and restaurant industries cratered, to move the correction forward.

The change is found in Section 2307 of the sprawling CARES Act, "Technical Amendments Regarding Qualified Improvement Property," and is only eight lines long. A technical amendment is generally regarded as one made to correct grammar, style, punctuation or other small matters in the text of a law.

“Since the change in the law is retroactive, that will help businesses that have invested in the interior portions of their properties in recent years," Sherman & Howard attorney Ryan Christ said. "They will be allowed to amend their prior year’s tax returns and receive a refund, adding to their cash reserves."

Property owners will benefit, but so will tenants that typically invest heavily in their space, such as retail outlets and restaurants, Christ added.

The change also will incentivize businesses to invest in future interior improvements, Christ said, as the 2017 tax law intended — resulting in a win for real estate when retail and restaurants, especially, badly need it.