Depreciation – the IRS playground

Tax Rules for Qualified Leasehold Improvements

Article written by EricBank

Many small businesses, especially retailers, restaurants and service providers, lease offices, buildings, warehouses and storefronts rather than allocating capital for their purchase. Often, the lessees make improvements to the leased properties, such as installing fixtures, lighting and alike. Certain types of leasehold improvements made before Jan 1, 2014 qualify for tax breaks by way of bonus depreciation-- half of the cost in the first year and the remainder over 15 years. Businesses can also depreciate non-qualified leasehold improvements, albeit at a slower rate.

Qualified Leasehold Improvement Property

The Internal Revenue Service requires that leasehold improvement property meet certain requirements to receive bonus depreciation. First of all, qualified property is limited to interior space of a non-residential structure. The lessee must exclusively occupy the space and the lease must allow the improvements. Improvements made during the property's first three years of service don't qualify. In addition, the property must fall under the Section 1250 classification for depreciable structural components and buildings. Improvements made after Jan. 1, 2014 don't qualify for bonus or accelerated depreciation.

Qualifying Improvements

Once meeting the general IRS criteria, a business can count almost any upgrade or modification to the leased property made before 2014 as a qualified leasehold improvement. This includes any money the business spends to improve HVAC equipment, doors, ceilings, non-structural partition walls, lighting fixtures, sprinkler systems, plumbing and electrical systems. But here is an important twist: because it doesn't sit within leased interior space, installing rooftop HVAC equipment doesn't qualify for bonus depreciation.

Non-Qualified Improvements

You can still depreciate leasehold improvements you make after 2013, but must use the regular 39.5-year depreciation period. This includes money you spend on improvements to escalators and elevators, building enlargements, common-area structural component improvements and internal framework improvements. Leasehold improvements don't qualify if the lessee and lessor are related -- family member, affiliated group members, trustees, executors and corporate subsidiaries.

Subsequent Owners

If the lessor makes qualified leasehold improvements and then sells the property to a new lessor, the tax benefits might not follow. For the improvement qualification to continue, one of the following must apply:

·       The old and new lessees are the same taxpayer,

·       The property passes to the new lessor after the original lessor's death,

·       The property passes from one corporation to an acquired corporation, or

·       The old and new lessors barter the property for another one and maintain the original cost basis

Other Depreciation Changes for 2014

2014 saw other changes to depreciation rules. For example, the depreciation limits that provide for immediate expensing of five-, seven-and 15-year property changed, from a $500,000 limit in 2013 to a $25,000 limit in 2014. Section 179 business property generally includes:

·       Equipment

·       Tangible personal property used by the business

·       Vehicles with gross weight exceeding three tons

·       Computers and off-the-shelf software

·       Furniture

·       Attached, non-structural building components, such as a printing press

Other 2014 changes saw the expiration of

·       The seven-year depreciation period for entertainment complexes exhibiting motor sports

·       Accelerated depreciation afforded to Indian reservation property

·       The three-year depreciation period for race horses