Qualified Improvement Property Under Section 168(e)(6): How Restaurant, Retail, and Office Build-Outs Unlock 15-Year Recovery and 100% Bonus Depreciation

Imagine you just signed a lease on a 6,000-square-foot retail space and dropped $480,000 into transforming it from a generic shell into a customer-ready store. New interior walls, lighting, finishes, ceilings, flooring, fire suppression, a custom service counter, and HVAC modifications to handle the new layout. Under the default rule for commercial real estate, every dollar of that build-out would be depreciated over 39 years — about $12,300 of deduction per year while you write the rent checks today.

There is a much better answer hiding inside Internal Revenue Code Section 168(e)(6) called Qualified Improvement Property (QIP). With the right classification and a clean placed-in-service date, that same $480,000 can be deducted 100% in year one. The difference is not academic. It is a roughly $100,000–$170,000 swing in cash taxes for a single typical tenant build-out, and most operators leave it on the table because their CPA never asked the right questions during construction.

This guide walks through what QIP is, the four-step test that determines whether your improvements qualify, the trap doors that disqualify projects, the law's twisting history from the TCJA glitch through the CARES Act fix to the OBBBA's 100% restoration, and how to use Form 3115 to claim catch-up deductions for prior-year projects that were misclassified.

What Section 168(e)(6) Actually Says

Section 168(e)(6) defines QIP as "any improvement made by the taxpayer to an interior portion of a building which is nonresidential real property" as long as the improvement is placed in service after the building itself was first placed in service.

Read that twice, because every clause matters.

• Improvement made by the taxpayer — You (or someone you paid) did the work. Property you simply purchased with the building does not become QIP just because someone improved it before you bought it.
• Interior portion — Outside walls, parking lots, sidewalks, signage, façade work, and rooftop equipment are not QIP. The work must be on the inside of the existing envelope.
• Of a building — Land improvements and freestanding personal property are handled under different rules (often 15-year land improvements or 5/7-year personal property anyway, which is fine).
• Nonresidential real property — Apartments, single-family rentals, and other residential rental property are excluded. QIP is a commercial concept.
• After the building was first placed in service — Day-one new construction does not become QIP simply because it is inside. The building must already be in service before the improvement.

When property meets that definition, it gets a 15-year recovery period under the General Depreciation System (GDS), uses straight-line depreciation, follows the half-year or mid-quarter convention, and — critically — becomes eligible for bonus depreciation under Section 168(k).

The Three Statutory Exclusions

Even when a project sits inside a nonresidential building and improves the interior, Section 168(e)(6) carves out three categories that cannot be QIP. These exclusions trip up restaurants and retailers constantly.

1. Enlargements of the Building

If the project expands the square footage of the building, the enlargement is not QIP. Bumping out a wall to add 200 square feet of dining room, building a mezzanine over the prep area, or extending a floor plate over previously unenclosed space all count as enlargement, regardless of how small the addition is. The IRS treats these as structural expansions, not interior upgrades.

You can still classify the non-enlargement portion of the same project as QIP, but the costs need to be cleanly separated. This is where a cost segregation study earns its fee.

2. Elevators and Escalators

Installing, replacing, or upgrading elevators and escalators is excluded by statute, even when the elevator is purely interior. These are treated as 39-year building components. Operators converting a multi-floor space sometimes assume the new elevator is just another tenant improvement; it is not.

3. Internal Structural Framework

Load-bearing walls, columns, girders, beams, trusses, and the primary lateral system are part of the building's structural skeleton and stay on the 39-year schedule. The interior partitions you build between those structural elements are fine. The exclusion targets the bones, not the build-out.

What Typically Qualifies (And What Does Not)

A practical way to think about QIP is to walk a contractor's punch list room by room. Here is how typical line items break down for a restaurant or retail interior build-out.

Usually QIP-eligible:

• Interior non-load-bearing partition walls and drywall
• Drop ceilings, acoustical ceiling tiles, and grid systems
• Interior doors, frames, and hardware
• Wall and ceiling finishes (paint, wallcovering, decorative wood)
• Interior lighting fixtures that serve the tenant space
• HVAC modifications and ductwork serving the interior
• Plumbing rough-in and fixtures (subject to function tests)
• Fire protection and sprinkler modifications
• Built-in millwork attached to interior walls

Usually NOT QIP (often 5-, 7-, or 15-year personal property or 39-year structural):

• Roof, foundation, exterior walls, windows, parking lot, sidewalks → 39-year structural
• Elevators and escalators → 39-year structural (statutory exclusion)
• Square-footage additions → 39-year structural (enlargement exclusion)
• Restaurant kitchen equipment, point-of-sale systems, decorative lighting fixtures, furniture, signage → typically 5- or 7-year personal property (better than QIP)
• Site work, fencing, landscaping → 15-year land improvements

Notice that some assets are better off outside QIP because they qualify for shorter recovery periods. The point of a cost segregation study is to push every dollar of the build-out into the shortest legitimate class, not to maximize the QIP bucket.

The Tortured History: Why the Recovery Period Matters

Before getting to the planning, it helps to know how this provision became one of the most expensive drafting errors in U.S. tax history.

Pre-TCJA: Three Separate Categories

Before 2018, the Code distinguished among qualified leasehold improvements, qualified restaurant property, and qualified retail improvement property, each with its own definition and a 15-year life. The categories were similar but had different lease-relationship rules, ownership tests, and waiting periods.

TCJA (2018): The Drafting Error

The Tax Cuts and Jobs Act tried to simplify the mess by collapsing all three into one new category, Qualified Improvement Property, with the broader Section 168(e)(6) definition. The drafters intended to assign QIP a 15-year recovery period and make it eligible for the new 100% bonus depreciation. But the enacted statute forgot to write in the 15-year life. Without the explicit 15-year designation, QIP defaulted to 39-year nonresidential real property — and 39-year property is not bonus-eligible.

For more than two years, businesses making major build-outs were stuck depreciating tenant improvements over 39 years with no bonus depreciation, even though every committee report said Congress had meant otherwise.

CARES Act (2020): The Retroactive Fix

In March 2020, Congress fixed the glitch retroactively as part of pandemic relief. The CARES Act assigned QIP a 15-year GDS recovery period (20-year ADS) effective for property placed in service after 2017, making it bonus-eligible.

This created an enormous look-back opportunity. Taxpayers who had placed QIP in service in 2018 or 2019 and depreciated it over 39 years could file Form 3115 to change accounting method, claim a Section 481(a) catch-up adjustment, and recover all the missed depreciation in a single year. Many large restaurant and retail chains generated nine-figure deductions that way.

TCJA Phase-Down (2023–2026)

Bonus depreciation under the original TCJA was scheduled to phase down: 100% for property placed in service through 2022, then 80% (2023), 60% (2024), 40% (2025), 20% (2026), and 0% thereafter. For a few years, QIP planning required knowing exactly which year a project hit "placed in service" to lock in the right bonus rate.

OBBBA (2025): 100% Permanently Restored

The One Big Beautiful Bill Act, signed into law on July 4, 2025, permanently restores 100% bonus depreciation for property both acquired and placed in service after January 19, 2025. QIP is explicitly included. The Section 179 limit was also bumped to $2.5 million, with the phaseout threshold raised to $4 million.

Transition trap: Property acquired on or before January 19, 2025, but placed in service after that date stays under the old phase-down schedule. So a project where the construction contract was signed in December 2024 but completion slipped to mid-2025 may end up at only 40% bonus, not 100%. Read your contracts for binding written commitment dates before assuming the new rules apply.

A Worked Example: Restaurant Build-Out

A small operator signs a 10-year lease on a 4,500-square-foot space that previously housed a clothing boutique. Total interior build-out cost is $540,000, broken down as:

Assume the build-out is placed in service in August 2026, after the OBBBA's January 19, 2025 effective date. With QIP and personal property both at 100% bonus, the operator deducts the full $540,000 in 2026.

Compare to the world where the operator's CPA never broke out QIP and treated the entire $540,000 as 39-year leasehold improvements:

• 39-year straight-line, half-year convention: roughly $6,900 of depreciation in 2026.
• Cash-tax delta at a 37% federal rate plus 6% state: about $230,000 of federal-plus-state tax pulled forward into year one.

That cash funds working capital, equipment payments, and lease deposits during the riskiest phase of the business. Two-thirds of restaurants fail in the first five years; the year-one tax check matters.

Bonus Depreciation vs. Section 179 vs. Straight-Line

Once an asset is classified as QIP, the operator still has three choices for how to deduct it.

Section 168(k) Bonus Depreciation

The default for QIP placed in service after January 19, 2025, is 100% bonus depreciation. You can elect out of bonus on a class-by-class basis (not asset by asset), which can be useful when:

• You have NOLs you cannot use or that would be limited by Section 382 or the Section 461(l) excess business loss rules.
• You expect substantially higher marginal rates in future years.
• Bonus would push your QBI deduction below useful thresholds.

The election-out is annual and irrevocable for the year, made on Form 4562.

Section 179 Expensing

Section 179 lets you immediately expense up to $2.5 million of qualifying property in 2025–2026 (subject to inflation indexing), phased out dollar-for-dollar starting at $4 million of total qualifying additions. QIP qualifies for Section 179. Unlike bonus depreciation:

• Section 179 is limited to taxable income from active trades or businesses (no NOL creation).
• It is elected asset by asset.
• It has its own phase-out for high-volume buyers.

When bonus is at 100%, the Section 179 election usually does not change the deduction in year one, but it can interact differently with state tax rules. Many states do not conform to bonus depreciation (or only partially), but they generally conform to Section 179 with their own (often lower) limits. Choosing Section 179 over bonus for some assets can avoid a state-level deferral.

Straight-Line 15-Year (or 20-Year ADS)

Electing out of bonus and skipping Section 179 leaves you with a 15-year straight-line schedule (or 20-year if you are on the Alternative Depreciation System, which is required for certain real property trades or businesses that elect out of the Section 163(j) interest limitation). This is the right answer for taxpayers who specifically need to spread deductions.

Cost Segregation: The Engine That Drives QIP Planning

QIP planning is rarely a single-line accounting decision. It is usually the output of a cost segregation study — an engineering-and-tax review of construction documents, invoices, and AIA G702 pay applications that allocates total project cost across the correct recovery classes.

A good cost seg study on a tenant build-out typically:

1. Splits the project into envelope (39-year), QIP interior (15-year), land improvements (15-year), and personal property (5- or 7-year).
2. Identifies enlargement costs, elevator/escalator work, and structural framework that must stay 39-year.
3. Documents the placed-in-service date for each asset class, because bonus rates depend on when each asset was ready and available for its intended use, not when the lease started.
4. Produces a defensible audit trail tying each line item to invoices, blueprints, and IRS guidance (Hospital Corp. of America, the cost-seg "13-factor" test, and the relevant private letter rulings).

A study generally costs $5,000–$15,000 for a small build-out and pays for itself many times over. For an in-house team, the same logic still applies: track each invoice into the correct class as you go, not at year-end.

Catch-Up Deductions for Old Projects: Form 3115

What if you placed a tenant build-out in service in 2021, your CPA put the whole thing on 39-year, and you never claimed any bonus? You are not stuck.

A change from an impermissible depreciation method (or recovery period) to a permissible one is generally Designated Change Number 7 (or related codes) under Rev. Proc. 2024-23 — an automatic accounting method change. You file Form 3115, "Application for Change in Accounting Method," with the current year return. The mechanics:

• Compute what depreciation should have been taken under the correct method from the original placed-in-service date through the year before the change.
• Compute what depreciation was actually taken.
• The difference is the Section 481(a) adjustment — a one-time catch-up deduction (or income pickup, if negative) recognized in the year of change.

Bonus depreciation that was never claimed on prior-year QIP can frequently be recovered through this mechanism, subject to whether bonus was elected out, the relevant Rev. Procs. for QIP-specific relief, and statute-of-limitations realities for amended returns. Because the rules around QIP catch-up have evolved (CARES Act notices, Rev. Proc. 2020-25, and several follow-on procedures), this is one of those areas where the right move is to scope the project with a tax specialist before assuming the deduction is available.

Common Planning Mistakes

After watching dozens of build-outs, the same handful of mistakes show up over and over.

1. Treating the whole project as 39-year leasehold improvements. The default in many tax software packages is one line for "leasehold improvements, 39 years." If no one reclassifies, the deduction stays buried for decades.
2. Confusing QIP with land improvements. Parking lot work, signage, and fencing are not interior and never qualify as QIP, even though they may already get 15-year treatment as land improvements.
3. Ignoring the enlargement exclusion. Adding 100 square feet anywhere in the build-out can disqualify that portion of costs from QIP. Cleanly separating enlargement from interior work is essential.
4. Missing the placed-in-service date. Bonus rates depend on when each asset is ready for use. A project that finishes the kitchen in November but the dining room in February straddles two tax years — and possibly two different bonus rates if it crosses the OBBBA effective date.
5. Forgetting state conformity. If your state decouples from federal bonus depreciation, the federal QIP deduction generates a state deferred tax liability. Tracking the federal-state book-tax difference correctly is what separates a clean trial balance from a multi-year mess.
6. No documentation. Three years later when the IRS questions the classification, "my contractor said so" is not a defense. Keep blueprints, contracts, and a cost seg report.

Where Bookkeeping Comes In

QIP planning lives or dies on the quality of your records. The depreciation classification is only as good as the underlying invoices, contract change orders, and placed-in-service evidence. That means:

• Tag every construction invoice to a class (QIP, personal property, land improvement, 39-year structural) as you book it.
• Keep a running depreciation schedule for federal and each state where conformity differs.
• Reconcile the contractor's final AIA G703 schedule of values to the GL line items so the cost seg engineer is working from clean numbers.
• Maintain a placed-in-service log with the date each portion of the project became ready for its intended use.

Doing this with a spreadsheet is workable for one location. Doing it with three locations, two states, and a mix of QIP and personal property at different bonus rates is where most operators lose track. A plain-text general ledger that gives you full audit history per account, per tag, and per date — without locking your data inside a proprietary database — makes the year-end conversation with your CPA dramatically shorter.

Keep Your Build-Out Records Audit-Ready from Day One

Whether you are opening a single restaurant or rolling out a national retail concept, the value Section 168(e)(6) creates depends entirely on documentation that survives an IRS exam years later. Beancount.io gives you plain-text accounting that is transparent, version-controlled, and easy to tag — so every QIP invoice, change order, and placed-in-service date is preserved in human-readable form your accountant and your future auditor can both follow. Get started for free and see why developers and finance professionals are switching to plain-text accounting.