Depreciating Leasehold Improvements

Whether you are a landlord or a tenant, some of the leasehold improvements that you make qualify for favorable depreciation and property expensing rules that don't apply to most other building improvements.

Specifically, so long as you didn't begin construction before Sept. 9, 2010, improvements that you make that are (1) “qualified leasehold improvement property” (described below) and (2) placed in service after Sept. 8, 2010 and before Jan. 1, 2012 (Jan. 1, 2013 for certain projects) are generally eligible for 100% bonus depreciation. That means that the full cost of the improvements is presently deductible.

Note also that even if you did begin construction of qualified leasehold improvement property before Sept. 9, 2010, the property can generally qualify for (1) 50% bonus depreciation in the year that the improvements are placed in service (the placed-in-service year) if placed in service before Jan. 1, 2013 (Jan. 1, 2014 for certain projects) and (2) depreciation of the remaining 50% of the cost of the improvements in the placed-in-service-year and over the next 14 years if the improvements were placed in service before Jan. 1, 2012 (the next 38 years if placed in service after Dec. 31, 2011, see below).

Further note that even if property is ineligible for 100% bonus depreciation, you may be able to elect to “expense” (i.e., deduct in the placed-in-service year) up to $250,000 of the cost of qualified leasehold improvement property placed in service in tax years that began in 2010 or 2011. Eligibility for the expensing election depends on the size and nature of your other investments in business property.

These special rules are a dramatic departure from the general rule that deductions for the cost of non-residential buildings, or improvements to the buildings, are allowed over a 39-year period.

Many, but not all, improvements made under a lease meet the requirements for being qualified leasehold improvement property. These requirements include, but aren't limited to, the requirements that the improvements not enlarge the building, not be attributable to internal structural framework and not be placed in service three years or sooner after the building was first placed in service. I'm available to help you determine whether any improvements that you have in mind meet the requirements. Also, I can help you identify improvements that, although attached to the building, are, for depreciation purposes, considered to be machinery or equipment and, thus, where 100% bonus depreciation doesn't apply, qualify for depreciation periods considerably shorter than 15 years.