Businesses that make certain improvements to leased property can qualify for a special tax break. As of 2013, you can depreciate half of the improvement’s cost in the first year. You depreciate the remainder over a 15-year period. If you make non-qualified leasehold improvements, you can’t take the first-year bonus depreciation and might have to depreciate the improvements over a period longer than 15 years.
Qualified Leasehold Improvement Property
Leasehold improvement property must meet certain Internal Revenue Service requirements to qualify for bonus depreciation. The property must be located in the interior part of a nonresidential building. The improvement must be allowed under the terms of the lease, in a part of the building occupied exclusively by the lessee. You can’t make the improvement during the first three years after the building goes into service. On a technical note, the property must be classified as Section 1250 property, which basically includes depreciable buildings and structural components.
Qualified Leasehold Improvements
If you satisfy all the other requirements, qualified leasehold improvements can be just about any change or upgrade to the leased property. This includes money spent to improve the electrical or plumbing system, sprinkler systems, lighting fixtures, non-permanent partition walls, ceilings, doors and heating/ventilation/air conditioning equipment. However, HVAC equipment you install on the roof of the building doesn't qualify, because it doesn't reside within the interior space you lease.
Money you spend to improve the property you lease doesn't qualify for bonus depreciation if it pays for the enlargement of the building, improvements to elevators and escalators, improvements to structural components in the common area of a building or to the internal structural framework. Another reason to disqualify a leasehold improvement is that the lessor and lessee are related. This includes relationships among family members, members of an affiliated group, subsidiaries of the same corporation, and executors or trustees.
Any qualified leasehold improvements made by the property owner -- the lessor -- might not remain qualified for a new lessor. The improvements maintain their qualification if the new lessor inherits the property from the original lessor, if the old and new lessees are substantially the same taxpayers, or if the new lessor is a corporation that carries over the assets from an acquired corporation. Another way for the new lessor to maintain the qualification is if the property is bartered for another property and the cost basis of the property remains unchanged.
- Eisner Amper: CCA Further Clarifies “Interior” for Qualified Leasehold Improvement Property
- Internal Revenue Service: Publication 946 How to Depreciate Property
- Internal Revenue Service: Publication 544 Sales and Other Dispositions of Assets
- BCG & Company: Making Tenant Improvements? Take Advantage of the Qualified Leasehold Improvement Rules
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