Does a post-service remodel of a rental property bedroom meet the criteria for qualified improvement property and 15-year depreciation under IRS rules?
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To determine whether a post-service remodel of a rental property bedroom qualifies as "qualified improvement property" (QIP) and is eligible for a 15-year recovery period under the Internal Revenue Code, we must analyze the statutory definition of QIP, the nature of the property, and the applicable depreciation rules.
1. Definition of Qualified Improvement Property (QIP)
Under IRC §168(e)(6), QIP is defined as any improvement made by the taxpayer to an interior portion of a building which is nonresidential real property, if the 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,.
Additionally, the improvement must be made by the taxpayer (i.e., not by a previous owner), and must be to an interior portion of a building that is classified as nonresidential real property.
2. Nonresidential Real Property vs. Residential Rental Property
The critical issue is whether the property in question is "nonresidential real property." Under IRC §168(e)(2)(A), "residential rental property" is defined as any building or structure if 80% or more of its gross rental income for the taxable year is rental income from dwelling units. A "dwelling unit" is a house or apartment used to provide living accommodations, but does not include units in hotels, motels, or similar establishments where more than half the units are used on a transient basis,.
If the property is residential rental property (e.g., an apartment building, single-family rental, or any property where 80%+ of the gross rental income is from dwelling units), it is not nonresidential real property. QIP only applies to improvements to nonresidential real property.
3. Application to a Rental Property Bedroom Remodel
- If the rental property is residential rental property (i.e., the property is used for dwelling units and meets the 80% test), then improvements to a bedroom (or any other interior portion) do not qualify as QIP. Such improvements are depreciated as part of the residential rental property, which has a 27.5-year recovery period under MACRS, not 15 years,.
- If the property is nonresidential real property (e.g., an office building, retail store, warehouse, etc.), and the bedroom is part of an interior improvement to such a building, then the improvement could potentially qualify as QIP, provided it is not attributable to the enlargement of the building, elevators/escalators, or the internal structural framework, and is made by the taxpayer after the building was first placed in service.
4. Additional Considerations
- The IRS has informally indicated that for mixed-use buildings (e.g., ground-floor retail with apartments above), whether an improvement qualifies as QIP depends on the building’s use in the year the improvement is placed in service. If the building is residential rental property in that year, improvements do not qualify as QIP.
- Improvements to residential rental property are not QIP, regardless of whether the improvement is to a bedroom, kitchen, or other interior space.
5. Depreciation Period
- QIP: If the improvement qualifies as QIP (i.e., to nonresidential real property), it is depreciated over 15 years (GDS) or 20 years (ADS), and is eligible for bonus depreciation if placed in service after 2017,.
- Residential Rental Property: Improvements to residential rental property are depreciated over 27.5 years (GDS) or 30 years (ADS), and are not eligible for QIP treatment.
6. Conclusion
A post-service remodel of a rental property bedroom does NOT meet the criteria for qualified improvement property and 15-year depreciation under IRS rules if the property is residential rental property. Such improvements are depreciated as part of the residential rental property over 27.5 years (GDS). Only improvements to the interior of nonresidential real property can qualify as QIP and be depreciated over 15 years,.
If you have a mixed-use property or a unique fact pattern, further analysis may be required to determine the building’s classification in the year of the improvement. If you believe your property may be nonresidential real property, please provide more details for a more tailored analysis.
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