Qualified Improvement Property (QIP)

By Jason Watson, CPA
Posted Monday, September 15, 2025

You might think this section is not too sexy since it primarily pertains to nonresidential property, but there is neat exception. We won’t discuss the mixed-use apartment building (residential) that has first-floor retail space (nonresidential); that is a can of facts and circumstance worms.

Qualified Improvement Property (QIP) is defined as any improvement made to the interior of a nonresidential building after the building is placed in service and is eligible for bonus depreciation. Improvements exclude expansion of the building, elevators and escalators (specifically called out, really?!), and changes made to a building’s internal structural framework. Oh, and let’s not forget that residential property also does not qualify.

Here is a bullet list of IRC Section 168(e)(6) for the ease of reading-

• Interior improvements only, to nonresidential real property.
• Excludes enlargements, elevators/escalators, structural framework.
• 15-year life so eligible for bonus depreciation under IRC Section 168(k).
• Also eligible for Section 179 expensing under IRC Section 179(f)(1).

What does this mean for you?

QIP on Short-Term Rentals

This nuance takes a bit of time to sort through. IRC Section 168(e)(2) reads-

Ok. What is a dwelling unit? IRC Section 168(e)(2)(a)(ii)(I) reads-

Great. What is transient basis? In Private Letter Ruling 139827-07, the IRS stated-

“Lodging facility” is defined in section 856(d)(9)(D)(ii) as a (l) hotel, (ll) motel, or (lll) other establishment more than one-half of the dwelling units in which are used on a transient basis. The term “transient” is not defined in section 856 or the regulations thereunder. However, for other purposes of the Code, a renter has generally been treated as “transient” if the rental period is less than 30 days. See section 1.48-1(h)(2)(ii) (which concerned definitions under old section 48 for purposes of the investment credit under former section 38); Shirley v. Commissioner, T.C. Memo 2004-188.

If your rental property has tenants or guests who stay 30 days or less, then they are considered transient. Subsequently, the rental property is not considered residential. Do you see how the tax code defines residential as receiving 80% of its income from dwelling units. Next, the code states that dwelling units do not include units if more than 50% of those units are used on a transient basis.

It’s defined in the negative. If you are not A, then you can only revert to B. This desire to be considered residential and to have the code respond with the criteria to be considered residential (versus wanting to be considered nonresidential) was not accidental. Huh?

Why did the IRS, Treasury, Congress and everyone define it this way? The original intent was to prevent real estate investors from using 27.5 years of depreciation versus 39.0 years. In other words, by calling a rental property a residential property, they were able to shrink the depreciation schedule (and increase current year depreciation deductions). There are all kinds of tax court cases involving nursing homes and dormitories discussing this residential versus nonresidential issue.

We can use this spat to our advantage. How?

If you have a rental property with an average guest stay of 30 days or less, and you drop $80,000 on a kitchen renovation after the property was originally placed in service (ready and available for occupancy, and held for rental use through advertising and related efforts), you can use either bonus depreciation or Section 179 expensing.

However, if you change structural components such as an exterior wall or load-bearing wall, then your kitchen renovation suddenly does not qualify, and must be depreciated over 27.5 or 39.0 years.

Sidebar: Don’t get twisted on short-term rental loophole and transient rental. Generally, short-term rentals are rentals where guests or tenants stay 30 days or less. However, for the short-term rental loophole where your rental property losses are no longer limited, the average guest stay must be 7 days or less and you must materially participate in the activity. We discuss this in detail in our section on the short-term rental (STR) loophole.

That’s bonus depreciation, Section 179 and qualified improvement property. If you do not use bonus depreciation or Section 179 on QIP, then you must depreciate the improvement property over 15 years for tax purposes. You don’t have a choice. In other words, if you have a nonresidential property and you shoot the money canon on that kitchen reno, then you will depreciate the cost over 15 years and not 39.

Consider this- it is unlikely you will have an interior improvement on a short-term rental that is depreciated over 39.0 unless there were structural components involved. Don’t forget the word “interior.”

Section 179 Expensing

The following blurb is often discussed when qualified improvement property is mentioned, but it is truly different (yet connected). IRC Section 179(e) reads-

So, IRC Section 179 is bringing in IRC Section 168 as we described earlier, and then adding specific items like roof, HVAC, fire and alarm systems and security systems that are specifically eligible for Section 179.

Neat. What does this mean for you? That kitchen reno we mentioned earlier would be eligible for bonus depreciation and Section 179 expensing. However, a roof or HVAC system is not QIP (because it is not an interior improvement) and would only be eligible for Section 179 expensing (not bonus depreciation). Again, this assumes a nonresidential rental property (average guest stay of 30 days or less).

There is some tax arbitrage available in replacing certain property since you can accelerate depreciation with bonus depreciation, or you can leverage Section 179 expensing. How? You purchase a rental property which naturally includes an HVAC system, and as such a part of the purchase price includes the value of the HVAC system. In turn, you depreciate the building and its components including the HVAC system. Neat.

Time goes by, and you replace the HVAC system. You might be able to immediately expense it with Section 179. However, the portion of the original building that included the HVAC system continues to depreciate. A double dip if you will. There is a thing called Partial Asset Disposition (PAD) that we will discuss in a bit where you might want to elect to dispose of the original HVAC system to recognize a tidy tax loss, and then also accelerate / expense the new HVAC system. Win win!

Short-Term Rental Benefits

Many real estate investors and rental property owners focus heavily on STRs because they are not subject to passive activity loss limits provided the activity qualifies (average guest stay of 7 days or less with material participation). However, short-term rentals, as you can see, are also designated as nonresidential and therefore have enhanced bonus depreciation and Section 179 expensing possibilities beyond typical rental properties.

Section 179 Versus Bonus Depreciation

For most interior improvements on nonresidential rental properties, you will have a choice between Section 179 and bonus depreciation. As we discuss in our accelerated depreciation and section 179 deduction section there are reasons to pick one over the other. Quickly-

• Section 179 cannot create a loss. It might still be fully deducted against other income sources depending on your situation. Bonus depreciation can create a loss (and impact the qualified business income deduction or QBID).
• Unused Section 179 at the entity level is trapped, and cannot be used against other income sources of the owners (for example, a rental property holding company). In other words, unlike owning a rental property in a single member LLC or in your own personal name, the unused Section 179 does not flow to the owners of a partnership (Form 1065) or S Corp (Form 1120S).
• Many states decouple from the federal tax code on bonus depreciation whereas many states allow for Section 179 expending with limitations.

Tax planning is a must.

Leveraging Qualified Improvement Property

Before the improvement, make sure your rental property is placed in service as we’ve discussed in our rental property in service defined section. The qualified improvement must be after the placed in service date. For example, you buy a rental property that you envision being a lovely short-term rental but you know the kitchen and bathrooms need some attention.

First, put the rental property into service where it is ready and available for its intended purpose. Otherwise, whatever you do will not be a qualified improvement but rather an improvement that is capitalized as a separate asset and depreciated over 39.0 years (assuming short-term rental).

Sidebar: Your material participation time clock starts at this time as well, and managing a large renovation can buttress your time log. See our time spent renovating section for more information since there are some pitfalls if your time is deemed investor time.

Next, ensure you have a few guest stays to get your average guest stay calculation. Large renovations might spill into the next tax year, and while your rental property is technically placed in service where expenses are tax deductible, it cannot be a short-term rental without the guest stays.

Next, take the rental property offline (it is still considered placed service since its intended purpose has not changed) and complete your qualified improvements. The smell of construction. Yum. Keep in mind that your reno cannot contain structural components or changes.

Next, take your big tax deduction against that high W-2 income through bonus depreciation or Section 179 expensing. No need for a cost segregation study since qualified improvement property is deemed 15-year property automagically.

Keep in mind that if you are improving the property to become a long-term rental immediately following the reno, that looks like a change in its intended purpose and might blow up your QIP deduction. The improvement must be done to a nonresidential property (30 days or less guest stays is nonresidential). Perhaps you muscle through a small period of short-term guest stays following the improvement to tick the box, and then change to a long-term rental.

Another consideration- you can also do this on a 30-day short-term rental (assuming no personal services are provided). Sure, your tax deduction will be limited by passive activity loss limitations, but if you have other rental income (profits) to offset or net against, then this works well. You can also build up a large passive loss carryover on Form 8582, and use that to chip away at future rental income. Huh?

Your rental property rents for 30 days at a time and earns $15,000 a year in taxable profit. You spend $100,000 on a kitchen renovation which creates a big tax loss yet limited by passive activity loss rules. In other words, you do not get an immediate tax deduction. However, this unallowed loss gets carried over into the future on Form 8582 as mentioned above, and will reduce your future rental profits to $0 until all the carryover losses are used.