Get Your Bonus for Leasehold Improvements

After five years of effort by Congress and real estate groups, some needed improvement to the depreciation rules for leasehold improvements has been put in place, tucked away in a small corner of the economic stimulus bill President Bush signed into law in March 2002.

That law, called the Job Creation and Worker Assistance Act, H.R. 3090, creates a so-called bonus depreciation allowance that gives taxpayers an additional depreciation deduction for 30 percent of the cost of their investments in leasehold improvements.

That’s not quite the change that the National Association of REALTORS® and other real estate organizations have been seeking. These groups want to reduce the recovery period for leasehold improvements from 39 years to 10 years. Still, the act moves the rules in the right direction.

Here are answers to some common questions on the provision revisions.

Q.How does the new bonus depreciation work?

A.Assume that a landlord makes $100,000 worth of improvements for a tenant. When the improvements are placed in service, the landlord can claim a bonus depreciation deduction of $30,000 (30 percent of $100,000). In addition, that year, the landlord may take a deduction for 1/39th of the remaining $70,000. The depreciation schedule continues—with a deduction of 1/39th of the amount each year—for the life of the improvements.

Q.Do the closeout rules enacted in 1996 still apply?

A. Yes. At the end of the lease, if the improved property is taken out of service, the owner may deduct any balance remaining in the depreciation account.

Q.What’s a qualified leasehold improvement?

A.Any improvement made to the interior space of a nonresidential building (except common areas, such as elevators and lobbies) as specified in a lease. The leased area must be occupied solely by the tenant (or subtenant) for whom the improvement is made.

Q.Is the bonus available only to landlords?

A. No. The bonus may be taken by either the landlord or the tenant (or subtenant). However, it can’t be taken by both. Landlords and tenants can determine how to allocate the deduction when they negotiate the lease.

Q.Will build outs made in a new building qualify for the bonus?

A.No. The bonus is available only if the building has been in service for more than three years.

Q.Will building enlargements qualify for the bonus?

A.No. Also, the bonus isn’t available for improvements to a building’s internal structural framework.

Q.Could this new incentive sweep me or my business into the alternative minimum tax?

A. No. Congress provided that the bonus depreciation allowance would be available in computing both regular and AMT liabilities.

Q.Is the new provision permanent?

A.No. It’s available only for leasehold improvements made after September 10, 2001, and before September 11, 2004. It’s too soon to tell whether Congress will extend the provision.