Is HVAC Qualified Improvement Property?
Uncover the tax implications of HVAC upgrades. Understand classification rules and how specific property improvements can lead to significant depreciation benefits.
Businesses undertaking commercial real estate improvements often question whether heating, ventilation, and air conditioning (HVAC) systems qualify as Qualified Improvement Property (QIP). Understanding QIP’s classification helps property owners maximize tax benefits. This article clarifies QIP criteria, how HVAC systems fit these definitions, and the resulting depreciation advantages.
Understanding Qualified Improvement Property
Qualified Improvement Property (QIP) is defined as any improvement made to the interior of a nonresidential building after the date the building was first placed in service. This classification was established to provide a simplified and favorable tax treatment for certain real property improvements. QIP explicitly excludes expenditures for building enlargement, elevators or escalators, and the building’s internal structural framework.
A drafting error in the Tax Cuts and Jobs Act (TCJA) of 2017 assigned QIP a 39-year recovery period, making it ineligible for 100% bonus depreciation. The Coronavirus Aid, Relief, and Economic Security (CARES) Act in March 2020 corrected this oversight. The CARES Act retroactively reclassified QIP as 15-year Modified Accelerated Cost Recovery System (MACRS) property, making it eligible for bonus depreciation for property placed in service after December 31, 2017.
HVAC Systems and QIP Eligibility
HVAC systems can qualify as Qualified Improvement Property, provided they meet specific criteria. For HVAC work to be considered QIP, it must be an improvement to an interior portion of a nonresidential building already placed in service. This includes projects such as replacing an existing HVAC system or upgrading components within the building’s interior.
HVAC improvements are excluded from QIP if they are part of a building enlargement, involve elevators or escalators, or affect the internal structural framework. For example, installing new HVAC units as part of an expansion that increases the building’s overall footprint would not qualify. Exterior HVAC units, such as those on a roof or a concrete pad adjacent to the building, are not improvements to the “interior” portion and do not qualify.
Depreciation Benefits for QIP
Designating property as QIP offers tax advantages through accelerated depreciation. QIP is classified as 15-year MACRS property, a shorter recovery period compared to the 39 years assigned to nonresidential real property. This shorter period allows businesses to deduct improvement costs more quickly.
Eligibility for bonus depreciation under Internal Revenue Code (IRC) Section 168(k) is a key benefit. This allows businesses to deduct a percentage of eligible property’s cost in the year it is placed in service. While 100% bonus depreciation began to phase out starting in 2023, decreasing by 20% each year until it reaches 0% in 2027, accelerating deductions remains an advantage. This accelerated deduction reduces taxable income, leading to tax savings and improved cash flow for businesses.
Differentiating HVAC from Other Property Classifications
Not all HVAC-related expenditures automatically qualify as Qualified Improvement Property; their classification depends on installation circumstances. Some HVAC components can be categorized as “personal property” if they are not permanently affixed and can be moved, such as a standalone air conditioning unit. These assets have shorter depreciation recovery periods, 5 or 7 years under MACRS, allowing faster deductions than QIP.
Conversely, if an HVAC system is considered a structural component of the building, it would not qualify as QIP. These structural components are depreciated over the longer 39-year period applicable to nonresidential real property. However, certain HVAC expenditures, even if they do not qualify as QIP, can still be eligible for Section 179 expensing. Section 179 allows businesses to deduct the full purchase price of qualifying equipment and software in the year it is placed in service, up to certain limits, offering another option for accelerated cost recovery.