Leasehold Improvements Depreciation ?'s

[Da Tax Lady]

I am working with a client whose CPA really mucked up their partnership returns since they started their business in 2005. I am working to amend them.

Basically, I am looking to see if there are any special rules related to leasehold improvements...My client owns a small strip mall with 4 or 5 clients in it. Due to the economy in the small town where it is located, teh Lessor is having to pay all or most of the buildout expenses for the new tenants moving in. None were restaurants until 2008, so no special rules there.

I am trying to give the benefit of the doubt to the CPA who prepared the original returns, and am searching for their logic in applying depreciation rules. The first year, in 2005, 2 new tenants moved in and signed 10 year leases. Some of the expenses were depreciated by the CPA over 7 years, and others over 15 years. In 2006, the new improvements were depreciated over 5 years for a 2 year lease. In 2007, he missed the improvements entirely, so fixing that one is easy.

My understanding is that leasehold improvements paid for by the Lessor are depreciable straight-line over 39 years. I have verified this with research. Questions for you:

1. Am I missing something? I'd like to think he didn't just screw this up.
2. Is the 30% bonus depreciation allowable for this type of improvement? We could use a little wiggle room for those first years on the amendment--otherwise my client is going to be SHOCKED with the result! $400,000 of improvements over 7 years is a heck of a lot different than 400K over 39!

[JG EA]

Moving up.

Things to think about - Make sure you have all the information before changing the depreciation. Many things that are now being represented as improvements may have expensed. Many improvements may have been in the nature of repairs. If it was totally a renovation taken at 7 years then there is a problem.

I think you are right that the owner depreciates normally. 39 years for real, 5, 7, etc. for 1245 property and leasehold limits are for the lessee. I don't know of any special lower time periods for the lessor, but maybe someone else does.

[Burke]

You need to research prior year leasehold improvement depreciation rules. They were indeed treatly differently, but had caveats. The types you could depreciate over shorter times (max 15 yrs) had to be directly attributable to the leased space, and not to general improvements to the overall property. And specified in the lease. They could be fully written off if the lease terminated. And they were subject to bonus depr rules as well. There was a requirement for how long the building had been owned, maybe 3 years? I can give you cites when I can access my resource documents tomorrow. Am not in the office today.

[Da Tax Lady]

More Details

My client purchased the property in January of 2005, then completed roughly 500K of improvements during 05. About 155K was electrical improvements bringing things up to code and rewiring the building to be used by multiple tenants, as it had previously been owned and used by a single owner. The remaining monies were for 2 buildouts for new tenants...I have the play-by-play info from the bank loan indicating to whom and for what, as well as the invoices from contractors. While there are SOME things that can be pulled out as repairs, the lion's share is really from buildouts to accomodate the new tenants.

The research I have conducted indicates that the Lessor uses 39 year straight line as the depreciation term, and there are situations where losses could result if the tenants leave before the end of the 39 years, which no one has, to date. I am not worried about departure issues, I'll research that once they happen and I've got this mess straightened out.

As the Lessee, improvements can be depreciated over the term of the lease, but not so for the Lessor according to the research I have found. I think it would bother me less if the prioor CPA had used the lease term as the depreciation period, at least then I'd understand why. There is no consistency or pattern that I've been able to discern at this point.

It also appears from my research that "qualified leasehold improvements" are eligible for bonus depreciation, which we will probably take advantage of to offset the huge difference in depreciation deduction! I know my client does not want to have to pay interest and penalty on 2.5 years of short-paid taxes, and getting the cash from this CPA will prove a challenge, as I've assisted other former clients of his in fixing errors made by him in prior years.

Thanks for the input--please let me know if you find any other details...thanks very much!

[Snaggletooth]

Da 'Preciation

Da Preciation is defined as an expression of thankfulness, as in

Da Tax Lady deserve Da 'Preciation of Da Message Board for bringing this up.

Tax Lady, welcome to the board. Good to have you bringing up issues such as this. I'm not much on the subject but I'm reading the thread so I can learn.

I have a client who owns a strip mall-type shopping center. Every time he has a new tenant he has remodeling, moving walls and cubicles, etc. to suit the tenant. This often runs into big money, but I expense it. Maybe I shouldn't, but I don't see anything wrong when these expenditures do not add anything of value to the building, and are only a matter of choice for the tenant.

[abby]

See TTB-9-20 Deluxe Version

Leasehold Improvements that are non-structural, such as the buildout that Snag and you describe, to the interior of the building are eligible for 15 year depreciation by the lessee or lessor (whichever pays for the buildout). The building has to be in service for at least 3 years prior.

Has to be according to the terms of the lease and for the benefit of the lessee only.

This rule was extended to 12/31/08.

Otherwise, the 39 year depreciation does apply - The Q LHI property for the 15 years has to be section 1250 property only. (Some of the costs might qualify for shorter depreciation of 5-7 years as sec 1245 property, though)

Once these Leasehold Improvements are abandoned, they can be written off. Not sure if the lessor can consider them abandoned until a new buildout is undertaken.

The bonus depreciation rules did apply to these Qualified LHI.

[Burke]

I agree with your post and so will not add further to it. Pub 946 has a rather complete discussion of the rules as well and covers this subject. It looks from addl info given, these would not qualify since the bldg had to have been placed in service more than 3 years prior to the leasehold improvements. If memory serves me correctly, these came about after 9/11 in a massive tax bill approved that year.