Favorable Depreciation Rules Can Provide Accelerated Tax Deductions
Author: Jess Myers
Landlords and tenants should know about some favorable tax depreciation rules for leasehold improvements placed in service before January 1, 2012. Specifically, for qualified leasehold improvements, depreciation deductions are allowed over a 15-year straight-line recovery period, considerably shorter than the 39 years generally required for nonresidential buildings and improvements. Qualified leasehold improvements also may, in some cases, be immediately expensed and deducted for tax purposes instead of being capitalized and written off over 15 years.
Improvements must meet the definition of “qualified leasehold improvements” to be eligible for these accelerated depreciation methods, and either the tenant or landlord may make the improvements. Generally, qualified leasehold improvement property includes interior improvements to a nonresidential building if they meet certain requirements:
- The improvements are inherently permanent additions or improvements to a building or similar structure, i.e., real property.
- The improvement is made under or pursuant to a lease.
- The improvement is made to the interior portion of the building, which is occupied exclusively by the lessee.
- The building was first placed in service more than three years prior to the improvement date.
Leasehold improvement examples include doors, non-load-bearing walls, electrical/plumbing systems, including sprinklers, and most HVAC systems.
Some improvements are explicitly excluded from qualified leasehold improvements and not eligible for accelerated depreciation, including:
- Improvements made pursuant to leases between related parties
- Building enlargement
- Elevators and escalators
- Structural components benefiting a common area
- Internal structural framework, including load-bearing walls, columns, girders, beams, etc., essential to the building's stability
Taxpayers may immediately expense up to $250,000 of qualified leasehold improvement costs under Internal Revenue Code Section 179 for tax years beginning in 2010 or 2011. Qualified leasehold improvements also are eligible for 50 percent or 100 percent bonus depreciation, offering another way for taxpayers to immediately expense assets that would otherwise be capitalized and depreciated. Unlike Section 179, there is no cap on bonus depreciation.
Landlords and tenants should remember improvements not qualifying as qualified leasehold improvements may still qualify for accelerated depreciation under other provisions. A cost segregation study to break out costs qualifying for immediate write-offs may prove particularly beneficial.
Through careful application of these accelerated depreciation provisions, taxpayers may be able to immediately deduct up to 100 percent of the cost of qualified leasehold improvements placed in service before January 1, 2012.
Applying the qualified leasehold improvement tests and accelerated depreciation rules can be complex. For more information, please contact your BKD advisor or Cary Jones at firstname.lastname@example.org.