Leasehold Improvements Depreciation Life Under MACRS

What changed after the TCJA and CARES Act

Before 2018, the tax code had three separate 15-year categories covering most commercial interior improvements: qualified leasehold improvement property (QLIP), qualified retail improvement property, and qualified restaurant property. Each had nuanced requirements — QLIP required an unrelated-party lease and improvements made more than three years after the building was first placed in service — but each delivered a 15-year MACRS life and bonus depreciation eligibility.

The Tax Cuts and Jobs Act (effective January 1, 2018) consolidated these three categories into a single "qualified improvement property" definition under IRC §168(e)(6), dropping the unrelated-party and three-year requirements. This should have simplified the rules and made QIP more broadly accessible. However, a drafting error omitted QIP from the explicit list of 15-year property in §168(e)(3)(E), causing it to default under the residual rule to 39-year property — the so-called "retail glitch."

The result was that for all of 2018 and 2019, QIP was technically 39-year property with no bonus depreciation eligibility. The CARES Act, enacted in March 2020, retroactively corrected this by explicitly listing QIP as 15-year property in §168(e)(3)(E)(vii). Because the correction was retroactive to January 1, 2018, taxpayers who had already filed returns for 2018 and 2019 treating their improvements as 39-year property could amend or use a method change to recover the acceleration they missed.

The 15-year rule and what it means for deductions

A 15-year depreciation life means the cost of QIP is deducted over 15 years rather than 39. That may not sound dramatic, but the numbers are significant. Consider a $500,000 leasehold improvement:

• Over 39 years (wrong, pre-CARES Act): $500,000 ÷ 39 ≈ $12,821 per year
• Over 15 years (correct, post-CARES Act): $500,000 ÷ 15 ≈ $33,333 per year

The annual deduction is 2.6 times larger under the correct 15-year treatment. More importantly, the 15-year classification unlocks bonus depreciation — which means a substantial portion (or all) of the cost can be deducted in year one rather than spread across decades. That front-loading of deductions creates real present-value savings, especially in high-rate tax environments.

MACRS method and convention for QIP

QIP falls under the General Depreciation System (GDS) as 15-year property with the following attributes:

• Method: Straight-line (not the 200% or 150% declining balance used for some other 15-year property, such as land improvements — QIP is expressly straight-line)
• Convention: Half-year convention (or mid-quarter if more than 40% of all personal property placed in service during the year lands in the fourth quarter)
• Recovery period: 15 years

Under the half-year convention, you receive half a year of depreciation in year one regardless of when during the year the improvement was placed in service. Year 16 receives the remaining half-year. So the annual deduction for years 2–15 is basis ÷ 15, and years 1 and 16 each receive half that amount (before any bonus depreciation).

Note that QIP uses straight-line, not the 150% declining balance that applies to regular 15-year land improvements. This is explicitly stated in §168(b)(3)(G): QIP must use the straight-line method. However, because most QIP is taken out in year one via bonus depreciation, the method distinction rarely matters in practice — there is nothing left to depreciate under the declining-balance method if 40%–100% is expensed in year one.

ADS life for QIP: 20 years

Under the Alternative Depreciation System (ADS), QIP has a 20-year straight-line recovery period. ADS is required for:

• Property used predominantly outside the United States
• Tax-exempt use property (certain property leased to tax-exempt organizations)
• Tax-exempt bond financed property
• Listed property not used predominantly for qualified business use (but this is personal property)
• Property of a real property trade or business that elects out of the business-interest limitation under IRC §163(j)(7)

The §163(j) interaction is the most important for real estate investors. Businesses with substantial interest expense may want to elect out of §163(j) to fully deduct their interest costs. The price is switching to ADS for all nonresidential real property, residential rental property, and QIP in that trade or business. Under ADS, QIP is 20 years rather than 15, and — critically — ADS property is not eligible for bonus depreciation. An investor making the §163(j)(7) election eliminates their first-year bonus deductions on QIP for that trade or business entirely. Model this tradeoff carefully before electing.

Bonus depreciation interaction with QIP

Because QIP is GDS 15-year property with a recovery period of 20 years or fewer, it is "qualified property" eligible for bonus depreciation under §168(k). The applicable bonus rate depends on when the improvement is placed in service:

• 100%: Placed in service after September 27, 2017, through December 31, 2022
• 80%: 2023
• 60%: 2024
• 40%: 2025
• 20%: 2026
• 0%: After December 31, 2026, under current statute

Bonus depreciation applies to the entire unadjusted depreciable basis of the QIP before regular MACRS begins. Taxpayers can elect out of bonus depreciation on a class-by-class basis by attaching a statement to their timely filed return. The election out is irrevocable once made for that year and class.

The phase-down and planning around it

The scheduled phase-down from 100% to 0% between 2022 and 2026 has meaningful implications for when to place improvements in service. If a tenant is planning a major build-out and has flexibility on timing, completing the build-out in an earlier year captures a higher bonus rate. Moving a $1 million build-out from December 2026 (20% bonus) to December 2025 (40% bonus) doubles the first-year bonus deduction from $200,000 to $400,000. The difference in present-value deductions at a 30% marginal rate is approximately $60,000 in year-one tax savings — a significant figure just for timing.

Congress has periodically modified and extended bonus depreciation rules; check IRS guidance for any subsequent legislation that may have modified the phase-down schedule after the publication of this guide.

Worked example: the 15-year math

A dental practice places $360,000 of interior improvements in service in a nonresidential building in October 2025. The building was placed in service in 2015, so these are improvements to an existing building that satisfy the QIP definition. The practice is not subject to ADS requirements.

MACRS classification: QIP, 15-year GDS, straight-line, half-year convention

2025 bonus depreciation rate: 40%

Year-1 bonus: $360,000 × 40% = $144,000

Remaining basis: $360,000 − $144,000 = $216,000

Year-1 MACRS (half-year on remaining basis): $216,000 ÷ 15 × 0.5 = $7,200

Total year-1 deduction: $144,000 + $7,200 = $151,200

Without bonus (elected out): Year-1 deduction = $360,000 ÷ 15 × 0.5 = $12,000. The bonus election produces 12.6× the year-1 deduction — $151,200 vs. $12,000.

Annual deduction years 2–15 (no additional bonus): $216,000 ÷ 15 = $14,400

Year-16 (final partial year): $216,000 ÷ 15 × 0.5 = $7,200

Total depreciation over the life of the QIP: $144,000 + $7,200 + ($14,400 × 14) + $7,200 = $360,000 — the full basis recovered, as expected.

ADS elections and §163(j) planning

Real property trades or businesses that elect out of §163(j) must use ADS going forward for their real property assets — they cannot cherry-pick. This means a landlord with a large interest-expense deduction who elects under §163(j)(7) will:

• Depreciate all nonresidential real property over 40 years (ADS, vs. 39-year GDS)
• Depreciate all residential rental property over 30 years (ADS, vs. 27.5-year GDS)
• Depreciate all QIP over 20 years (ADS, vs. 15-year GDS)
• Lose all bonus depreciation eligibility for QIP (ADS property ineligible)

The cost of the §163(j)(7) election in terms of lost QIP depreciation acceleration can be enormous. For a landlord with $2 million of QIP in the election year, switching from 40% bonus (2025) to 20-year ADS could defer $800,000 of first-year deductions to be spread over 20 years instead. That deferred deduction is worth roughly $800,000 × 0.33 (effective rate) / 20 = $13,200 per year — a real cost offset against whatever interest expense is unlocked. The election is irrevocable, so model it carefully with a tax advisor before making it.

Correcting 2018 and 2019 QIP

Taxpayers who placed QIP in service in 2018 or 2019 and depreciated it over 39 years (the wrong life, before the CARES Act fix) have several remediation options under Rev. Proc. 2020-25:

• Amended return: For 2018 or 2019 returns that were open, a taxpayer could file an amended return using Form 1040-X or Form 1120X to claim the 15-year life and any bonus depreciation.
• Form 3115 (change in accounting method): Even if the 2018/2019 return is no longer open for amendment, a taxpayer can file Form 3115 to change from the 39-year method to the correct 15-year method. This produces a Section 481(a) catch-up adjustment — all the excess depreciation that should have been taken in 2018 and 2019 (and the years since) flows through in a single lump-sum deduction in the year the Form 3115 is filed.

The §481(a) catch-up deduction can be very large if the QIP was substantial. It is generally taken entirely in the year of the Form 3115 filing (not spread over four years, because the adjustment is favorable). This is one of the more powerful retroactive tax opportunities for commercial real estate owners and tenants who had large 2018–2019 build-outs.

Frequently asked questions

Educational information and estimates only. Not tax advice. Tax rules change and vary by situation; consult a qualified tax professional before acting.

Related

• Leasehold Improvements Definition
• Tenant Improvements and Bonus Depreciation
• Rental Property Depreciation Calculator