Update: On September 13, 2019, the Internal Revenue Service issued its final regulations providing guidance on the expanded depreciation deductions included in the Tax Cuts and Jobs Act. These regulations did not correct the errors regarding deductions for qualified improvement property. A correction will now require an amendment to the tax law, which is not currently being contemplated.

On December 22, 2017, President Donald Trump signed the Tax Cuts and Jobs Act (Act) into law. The Act, which took effect on January 1, 2018, includes several changes to the Internal Revenue Code (IRC) affecting both commercial and residential real estate owners.

Shortly after the Act was passed, many typos and drafting errors were discovered. Some of these errors have unintended consequences for taxpayers. Two notable errors negatively impacting retailers and restaurant owners concern the deduction available for qualified improvement property and net operating losses.

A qualified improvement property is an improvement made to the interior of nonresidential real property. Under the IRC, taxpayers may deduct the cost of the qualified improvement property. This deduction is designed to encourage retail and restaurant chains to improve current locations, or expand into new locations even if the new location needs substantial improvements (see Legal Update, IRS Issues Safe Harbor for Accounting of Remodel-Refresh Costs Incurred by Retailers and Restaurants).

The Act changed the depreciation period of qualified improvement property with the intent to allow taxpayers to deduct the full cost of a qualified improvement property in the year the expenditure is made. However, due to a drafting error, the Act instead requires improvements to retail stores and restaurants to be depreciated over 39 years. The result is that taxpayers can only deduct 2.5% of the cost of the improvements in the year they were made, and the remaining 97.5% over 38 years.

Under the IRC, businesses that operate at a net loss in one year can use those losses to offset profits in another year to lower their tax burden. Prior to the Act, a taxpayer could carryforward their losses 20 years, or carryback their losses 2 years. The Act amended this rule, removing the ability to carryback losses, but instead allowing losses to carryforward indefinitely.

However, there is an error in the effective date of the provision that eliminates loss carryback. This means that businesses that had planned to carryback losses for tax years that began in 2017 will instead have to carryforward those losses. Businesses that were relying on the carryback to finance continued operations will now have to wait to receive that benefit in future years.

These errors disincentive rather than encourage landlords to make improvements to their retail and restaurant spaces, and hurt businesses operating at a loss by removing the ability to carryback their losses for the 2017 tax year. This has led to losses and confusion in the market as property owners decline opportunities to lease or purchase new store locations that require extensive improvements and lose the benefit of prior tax planning.

On June 5, 2018, over 100 retailers, restaurants, and trade groups sent a letter to lawmakers on the Senate Finance and House Ways and Means committees requesting the errors be corrected. While it is widely accepted that the Act contains errors, there is no timetable for their correction, so business owners should monitor the status of these provisions when tax planning.

For more information on the Tax Cuts and Jobs Act, see Legal Update, Tax Act Gives Cuts to CRE Owners and Limits Deductions for Homeowners.