Is a bedroom remodel completed after a rental property is placed in service considered qualified improvement property for 15-year depreciation on Form 4562?
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A bedroom remodel completed after a rental property is placed in service is not considered "qualified improvement property" (QIP) eligible for 15-year depreciation on Form 4562. Here’s a detailed explanation based on the relevant legal authorities and IRS guidance:
1. Definition of Qualified Improvement Property (QIP)
Under IRC §168(e)(6), as amended by the CARES Act and subsequent law, "qualified improvement property" is defined 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 the building was first placed in service. However, QIP does not include any improvement for which the expenditure is attributable to:
- The enlargement of the building,
- Any elevator or escalator, or
- The internal structural framework of the building.
2. QIP Applies Only to Nonresidential Real Property
The statute and IRS guidance are clear that QIP applies only to improvements to the interior of nonresidential real property. Nonresidential real property is defined as section 1250 property which is not residential rental property or property with a class life of less than 27.5 years.
- Residential rental property is defined as any building or structure if 80% or more of the gross rental income from such building or structure for the taxable year is rental income from dwelling units.
3. Bedroom Remodel in a Rental Property
A bedroom in a rental property is part of a dwelling unit. If the property is a residential rental property (such as a house, apartment, or other building where 80% or more of the rental income is from dwelling units), then it is not nonresidential real property. Therefore, improvements to the interior of a residential rental property, such as a bedroom remodel, do not qualify as QIP.
4. Depreciation of Improvements to Residential Rental Property
Improvements to residential rental property are depreciated as part of the building, using the same recovery period as the underlying property:
- 27.5 years under the General Depreciation System (GDS) using the straight-line method and the mid-month convention.
5. Form 4562 Reporting
On Form 4562, improvements to residential rental property (such as a bedroom remodel) should be reported as additions to the basis of the building and depreciated over 27.5 years, not 15 years. The 15-year recovery period for QIP is only available for improvements to nonresidential real property.
6. Supporting IRS Guidance
IRS Publication 946 and the Cost Segregation Audit Techniques Guide both confirm that QIP is not available for residential rental property. Only improvements to the interior of nonresidential real property can be treated as QIP and thus eligible for 15-year depreciation and bonus depreciation.
Conclusion: A bedroom remodel in a residential rental property is not QIP and must be depreciated over 27.5 years as part of the residential rental property, not 15 years as QIP. Only improvements to the interior of nonresidential real property can qualify as QIP for 15-year depreciation.
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