Improvements or Additions to Leasehold Property:
One of the emerging hot topics in tax depreciation is Leasehold Improvement Depreciation. Lately, there seem to be many questions revolving around what qualifications there are for depreciating leasehold improvements and what guidelines must be followed when doing so. This probably stems from the recent rules and allowances created through the initial law (Job Creation and Worker Assistance Act of 2002) through the stimulus plans of 2008 and 2009. Below, are the general rules behind depreciating qualified leasehold improvements as well the current changes that have been put into place.
Generally, additions and improvements to leasehold property are depreciated under the same rules as the real property being improved, had that real property been placed in service at the same time as the addition or improvement. In other words, additions or improvements to a building placed in service prior to MACRS would be depreciated under the current MACRS rules in effect at the time that the addition or improvement was placed in service. This normally would mean a 39 year recovery period for non-residential real property under straight line with a mid-month first year convention. However, there are many exceptions to this general rule, including how to handle Qualified Leasehold Improvements.
Here is what you need to know about Qualified Leasehold Improvements:
1) Effective date of 10/23/2004
2) It’s not elective if the qualifications below are met:
3) Qualified Leasehold Improvements must:
- A. Be made subject to a lease with a taxpayer as either the lessee or lessor
- B. Be made for a lease between unrelated parties
- C. Be where the leased portion is only occupied by the lessee.
- D. Be of Section 1250 Property (structural components such as walls, plumbing or certain wiring).
- E. Be placed in service more than 3 years after the building was initially placed in service
4) If these qualifications are met, the qualified leasehold improvements can be depreciated over 15 years under MACRS GDS Straight Line with Half-Year or Mid Quarter Convention. This is opposed to the normal 39 year recovery period with Straight-Line and Mid-Month Convention.
5) Section 179 does not apply since only Section 1245 property is allowable.
6) Bonus Depreciation at 50% has been extended until 12/31/2009
7) Section 1245 (Personal Property) may be depreciated under Cost Segregation Rules. This allows for a shorter recovery period of 5 or 7 years.
*There are also important exceptions for Qualified Restaurant Property and Qualified Retail Property. However, to keep things as simple as possible, these areas will be addressed in different posts which will be coming soon.
Hopefully this will have answered many questions about depreciating improvements or additions to leaseholds. If there is any additional information that you would like, please feel free to ask below in the comments or on the questions page.