• Leasehold Improvements-Planning for Taxes

    Leasehold improvements are modifications or additions to a commercial real estate that serve to make the property more suitable to the tenant’s needs.  Leases are negotiated so that these improvements are paid for by either the landlord or the tenant.  Furthermore, not all modifications are considered to be leasehold improvements in the eyes of the IRS.

    Allowable Improvements

    Certain types of improvements provide tax benefits.  Some of these are:

    • Lighting fixtures
    • Interior walls added
    • Drywall or acoustic ceilings
    • Floor coverings such as tile or carpet
    • Carpentry work associated with the interior changes
    • Restroom accessories

    The improvements must be made to an area occupied by only one lessee and must be made only after the building has been in use for three years.  Only interior improvements qualify.

    Disallowed Improvements

    Some modifications are not considered leasehold improvements by the IRS.  Therefore, some of the kinds of improvements that do not qualify are:

    • Adding on to the building or enlarging the square footage
    • Improvements to a common area
    • Escalators do not qualify
    • Elevators do not qualify
    • Modifying structural framework does not qualify

    How Improvements are Funded

    In some cases a TIA (Tenant Improvement allowance) is made a part of the lease agreement and the amount of the allowance is usually expressed as a certain number of dollars per square foot of leased space.  In addition, another way of doing it is for the landlord to allow a certain amount of rental credit to be applied to leasehold improvements.

    Another option is for the tenant to pay for his own improvements out of his pocket.  In this instance the improvements become the property of the landlord upon termination of the lease.

    How is the Accounting Handled?

    Generally speaking the lessee writes off  the cost of the leasehold improvements in as short a period as possible.  Therefore, improvements made with a rent credit should be expensed during the current period.  Larger projects over $50,000 with have to be capitalized and written off as a depreciating asset as opposed to an expense.  Consequently, the disadvantage of this is that you write off only a small portion of the project each year and it takes much longer to realize the tax benefit.  A depreciated capital expense must be depreciated over the shorter of:

    • The estimated useful life of the improvement
    • The remaining lease term

    Most noteworthy, there were five changes to the IRS rules governing leasehold improvements from 2001 to 2013.  Because these rules change so frequently it is always advisable to consult with your CPA before planning your work.

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