How Do I Depreciate Leasehold Improvements (QIP) to Save on Taxes?

What QIP is and what the tax code excludes

Qualified Improvement Property is any improvement a taxpayer makes to the interior of nonresidential real property *after* the building was first placed in service. That covers most of what a commercial buildout actually touches: new non-load-bearing walls and partitions, flooring, ceilings, interior lighting, interior doors, drywall and finishes, and the HVAC, electrical, and plumbing distribution that lives inside the leased space. Fire-protection and security systems inside the space generally qualify too.

The code carves out three specific things that are never QIP no matter where they sit. First, any enlargement of the building — an addition that increases square footage. Second, elevators and escalators. Third, the building's internal structural framework — load-bearing walls, the roof structure, and the foundation. If you add a mezzanine or knock down a bearing wall, those costs stay on a 39-year life with no bonus. Exterior work — parking lots, sidewalks, landscaping, exterior signage — also falls outside QIP, but those are 15-year land improvements, a separate class that is itself bonus-eligible, so don't bury them in the 39-year structure.

The distinction is worth real money because it sets the recovery period, and the recovery period decides whether you can accelerate the deduction at all. A dollar of true QIP rides a 15-year MACRS straight-line schedule and qualifies for bonus depreciation; a dollar misclassified as structure sits on 39 years and forfeits both advantages. Getting the classification right is the whole game.

Why the CARES Act fix matters

There is a piece of legislative history you have to understand before you touch a return from 2018 or 2019. The 2017 Tax Cuts and Jobs Act intended to give QIP a 15-year life and full bonus eligibility, but a drafting error left it out of the statute — the notorious "retail glitch." As written, QIP defaulted to a 39-year recovery period with no bonus depreciation, the opposite of what Congress meant.

The CARES Act (2020) retroactively corrected the mistake, restoring the intended 15-year life and bonus eligibility going all the way back to property placed in service after December 31, 2017. That retroactivity is the useful part. If you built out space in 2018 or 2019 and your accountant — reasonably, given the law at the time — put it on a 39-year schedule, you have been under-depreciating that asset ever since. The fix means you can recover it.

You don't have to amend those old returns to catch up. The cleaner route is a change in accounting method on Form 3115, which lets you take a single Section 481(a) catch-up adjustment in the current year equal to all the depreciation you should have claimed but didn't. On a large prior buildout, that can be a six-figure deduction landing in one tax year. Amending the affected years is technically available, but Form 3115 avoids reopening closed years and is usually the simpler filing.

Running the numbers on a real buildout

Concrete math makes the incentive obvious. Take a $500,000 leasehold buildout that is entirely QIP, placed in service in 2025, when the bonus rate is 40%. You deduct $200,000 in year one as bonus depreciation, then depreciate the remaining $300,000 straight-line over 15 years — roughly $20,000 per year.

At a 37% federal marginal rate, that $200,000 year-one deduction is worth about $74,000 in tax saved immediately. Compare that to the old 39-year treatment, where the full $500,000 would have thrown off only about $12,800 per year in depreciation — worth roughly $4,700 in annual tax at the same bracket. The difference between those two paths, discounted to present value at, say, 8%, is on the order of $50,000 to $80,000 on a half-million-dollar project. That gap is not a permanent tax cut — you eventually depreciate the same total basis either way — it is a timing benefit, essentially an interest-free loan from the IRS for the years you would otherwise have waited.

One caveat sets the entire calculation: the bonus rate is mid-phase-down. It was 100% through 2022, then stepped down 20 points a year — 80% in 2023, 60% in 2024, 40% in 2025, 20% in 2026, reaching 0% in 2027 unless Congress extends or restores it. The rate is fixed by the year you place the property in service, not the year you sign the lease or start construction, so confirm the current-year percentage before you model anything. Slipping a project from December into January can permanently cut your year-one deduction in half.

Stacking Section 179, bonus, and straight-line in the right order

You actually have three tools, and the smart move is layering them deliberately rather than reaching for one.

Bonus depreciation (Section 168(k)) applies automatically to all bonus-eligible property unless you affirmatively elect out. It has no dollar cap, and — critically — it can create or deepen a net operating loss that carries forward to future years. That makes it the workhorse for the bulk of a QIP buildout.

Section 179 expensing lets you immediately write off up to roughly $1.25 million of qualifying property (the 2025 limit, indexed annually and subject to a phase-out once total purchases exceed a much higher threshold). Its constraint is that it cannot create a loss — your 179 deduction is capped at your taxable income from the active business. Its advantage is reach: Section 179 covers certain nonresidential improvements that even bonus can't touch, including roofs, HVAC, fire-protection, and security systems on the building itself. Use 179 to grab the items bonus misses, or to dial the deduction to an exact figure.

Straight-line 15-year MACRS catches whatever you don't accelerate with the first two tools, spreading it evenly across the remaining life.

The ordering rule is fixed: Section 179 first, then bonus on what remains, then straight-line on the leftover basis. A common and costly mistake is loading everything onto 179 when you're income-limited, only to discover the deduction is capped below what you wanted. Sometimes the better cash-flow play is to let bonus do the heavy lifting precisely *because* it can generate a loss to carry forward, while reserving 179 for the roof-and-HVAC items bonus can't reach. There is no single right answer — model both paths against your actual taxable income with your CPA before you file.

Who gets the deduction: tenant versus landlord

The deduction follows whoever pays for and owns the improvement, not whose name is on the deed. That single principle resolves most of the confusion.

If the tenant pays for and owns the buildout, the tenant depreciates it as QIP over 15 years — regardless of the lease term. Even if your lease runs five years and the QIP life is fifteen, you depreciate over fifteen. The upside for a short lease: if you vacate early and surrender the improvements, you can generally write off the remaining un-depreciated basis as an abandonment loss in the year you leave, accelerating the rest of the deduction.

If the landlord funds the work through a tenant-improvement (TI) allowance, the landlord typically owns and depreciates those improvements as QIP. A true construction allowance under a qualified lease is generally not taxable income to the tenant. Where it gets granular is the split: if the landlord gives you, say, a $50 per square foot allowance and you spend more than that out of pocket, the portion you fund becomes your QIP to depreciate, while the allowance-funded portion stays with the landlord. Track that boundary line by line in the construction budget, because it is exactly where your deduction ends and the landlord's begins.

Don't leave personal property and safe-harbor deductions on the table

Two adjacent moves routinely get missed and each one leaves money behind.

First, separate Section 1245 personal property from the QIP. Items like cabinetry, modular furniture, decorative or specialty lighting, and specialized retail shelving may qualify as 5- or 7-year MACRS property, which is also bonus-eligible and depreciates even faster than QIP's 15 years. On a typical buildout, somewhere around 20% to 35% of total cost can be allocable to personal property. Pulling that out requires a cost segregation study — an engineering-based allocation of the total project cost into its proper asset classes. Without one, those faster deductions usually stay buried inside the 15-year (or worse, 39-year) bucket.

Second, use the de minimis safe harbor. The tangible property regulations let you immediately expense items costing $2,500 or less per invoice line (or $5,000 if you have an applicable financial statement) instead of capitalizing and depreciating them, provided you've adopted the election. On a buildout with a lot of small-ticket components, this can convert 5% to 15% of total cost into an immediate current-year deduction with none of the depreciation machinery. Ask your contractor for a line-item invoice so each cost category — drywall, flooring, electrical, plumbing, HVAC, millwork — is visible and the de minimis and cost-seg allocations are defensible.

State conformity, pass-through basis, and the traps that suspend your deduction

Federal treatment is only half the picture, and two issues quietly reverse a lot of expected savings.

Many states decouple from federal bonus depreciation. California and New York, among others, do not conform to Section 168(k), so you can take a large federal bonus deduction and still have to depreciate the exact same QIP slowly on your state return — often over the full recovery period. That forces you to maintain two separate depreciation schedules, federal and state, for the life of the asset. Notably, most decoupling states *do* still allow Section 179, which is one more reason 179 stays useful even in years when federal bonus is more generous — a 179 deduction may flow through to the state return where a bonus deduction would be added back.

Pass-through basis and at-risk limits are the other trap. If your business is an S-corp, partnership, or LLC, a bonus-driven net operating loss only helps you this year if you have enough tax basis and at-risk investment to absorb it. A loss suspended for lack of basis doesn't vanish — it carries forward until you have basis — but it does not offset this year's income, which quietly defeats the whole point of front-loading the deduction. Confirm your basis before you assume a year-one write-off actually lowers this year's bill.

Documentation that survives an audit

The IRS scrutinizes QIP claims because the classification is worth so much, so the paper trail matters. Three documents form the core of a defensible position: a detailed cost breakdown that separates QIP from non-QIP items, a placed-in-service date for both the building and the improvements, and — if you're a tenant — the lease agreement showing you're the party making and owning the improvements. Without these, an examiner can reclassify 15-year QIP as 39-year property and hand you back taxes, penalties, and interest.

Build the file as you go rather than reconstructing it later. Get the line-item contractor invoice, have a cost-segregation engineer or CPA allocate costs using IRS-accepted engineering-based methods, and keep permits and before/after photos of the space. Those photos are your strongest evidence if the IRS questions whether an improvement was genuinely interior rather than structural. And mind the placed-in-service timing rule: QIP must be placed in service *after* the building was first placed in service by anyone — so improvements a first tenant makes in a brand-new building qualify, but nothing counts if it predates the building's original in-service date. A well-documented claim both maximizes the deduction now and protects it under exam later.

Related questions

Can I still fix a 2018 or 2019 buildout I depreciated over 39 years?

Yes. The CARES Act correction is retroactive to property placed in service after 2017. File Form 3115 for an automatic change in accounting method and take a Section 481(a) catch-up deduction in the current year for the depreciation you missed — no amended returns required.

Does a short lease limit how fast I can depreciate QIP?

No. QIP always uses the 15-year schedule regardless of lease term. A five-year lease doesn't shorten it to five years. The upside runs the other way: if you vacate early and surrender the improvements, you can write off the remaining basis as an abandonment loss.

Are parking lots and sidewalks QIP?

No — those are land improvements, a separate 15-year MACRS class, not QIP. They are also bonus-eligible, so the acceleration benefit is similar, but you must classify them correctly rather than lumping them into either the interior QIP or the 39-year structure.

What's the difference between bonus depreciation and Section 179 here?

Bonus applies automatically, has no dollar cap, and can create a loss that carries forward. Section 179 is capped at taxable income and can't create a loss, but reaches items bonus can't — like roofs and HVAC on the building. Apply 179 first, then bonus.

FAQ

What exactly is Qualified Improvement Property?

QIP is any interior improvement to a nonresidential building placed in service after the building was first available for use. It includes new walls, flooring, ceilings, lighting, interior doors, and the HVAC, electrical, and plumbing distribution that's part of the interior buildout. Building enlargements, elevators, escalators, and the internal structural framework are specifically excluded.

Can I take bonus depreciation on QIP?

Yes, thanks to the CARES Act correction. QIP placed in service after September 27, 2017, qualified for 100% bonus through 2022, then the rate phases down 20 points annually: 80% in 2023, 60% in 2024, 40% in 2025, and 20% in 2026, reaching 0% in 2027 unless Congress acts. The rate locks to your placed-in-service year.

How does the 15-year schedule actually save money versus 39 years?

Depreciating over 15 years instead of 39 lets you deduct a much larger share of the cost each year, lowering taxable income sooner. A $150,000 improvement throws off about $10,000 in annual straight-line depreciation on a 15-year life versus roughly $3,850 on 39 years — and that's before any year-one bonus, which front-loads the benefit further.

What method do I use to depreciate QIP?

QIP uses the straight-line method over 15 years under MACRS. You can elect the alternative depreciation system (ADS), which stretches the period to 20 years, but that only makes sense in narrow cases — for example, an electing real property trade or business that opted out of the interest-limitation rules. For most taxpayers, the standard 15-year MACRS schedule plus bonus maximizes early deductions.

What if my buildout mixes QIP with non-QIP items?

Split it three ways. True QIP goes on 15 years and is bonus-eligible. Structural components — foundation, roof structure, load-bearing walls, framework — go on 39 years. Land improvements like parking lots and exterior signage go on a separate 15-year class that's also bonus-eligible. Misclassifying any one of the three changes your deduction, so have a professional allocate them.

Can a tenant claim QIP depreciation rather than the building owner?

Yes. The deduction follows whoever pays for and owns the improvement, not whose name is on the building. If you, the tenant, fund and own the buildout, you depreciate it as QIP over 15 years even on a shorter lease, and can write off remaining basis as an abandonment loss if you leave early. If the landlord funds it through an allowance, the landlord generally depreciates it.

Sources

• IRS Publication 946, "How to Depreciate Property" — https://www.irs.gov/publications/p946
• 26 U.S. Code § 168 (MACRS, QIP, and bonus depreciation) — https://www.law.cornell.edu/uscode/text/26/168
• 26 U.S. Code § 179 (election to expense certain depreciable property) — https://www.law.cornell.edu/uscode/text/26/179
• IRS, "Additional First Year Depreciation Deduction (Bonus) — FAQ" — https://www.irs.gov/businesses/small-businesses-self-employed/additional-first-year-depreciation-deduction-bonus-faq
• CARES Act (P.L. 116-136), H.R. 748, 116th Congress — https://www.congress.gov/bill/116th-congress/house-bill/748
• IRS Revenue Procedure 2020-25 (QIP change of accounting method) — https://www.irs.gov/pub/irs-drop/rp-20-25.pdf
• Treasury Regulation § 1.263(a)-1(f), de minimis safe harbor election — https://www.ecfr.gov/current/title-26/chapter-I/subchapter-A/part-1/section-1.263(a)-1
• IRS, "Cost Segregation Audit Techniques Guide" — https://www.irs.gov/businesses/cost-segregation-audit-techniques-guide-table-of-contents

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