When you improve your commercial real estate property, the work you do fits into one of two broad areas. A building improvement is something that you do for your building that changes its function, increases its value or extends its useful life.
A leasehold improvement on the other hand is something that you do to your building for a specific tenant's benefit. The two types of improvements get treated very differently from the Internal Revenue Service's perspective.
While building improvements may fundamentally alter the functionality or value of a property, a leasehold improvement is something that is undertaken specifically for the benefit of.a tenant.
Assessing Leasehold Improvements
Work that you do on a building for the exclusive benefit of a specific tenant is considered a leasehold improvement. The improvement must be located within the demising walls of the tenant's space and made as a result of requirements in the tenant's lease. Finally, the building must be at least three years old before any improvements can be counted as a leasehold.
Understanding Building Improvements
Anything you do to your building that changes its function, increases its value or extends its useful life is an improvement. Renovating the lobby to make it more attractive is an example of an improvement as is replacing all of the building's lighting fixtures with new high-efficiency fixtures.
Major repairs that extend the building's life, such as installing a new roof, are also considered improvements. Furthermore, changes that you make on the request of a tenant that are outside of the tenant's space, like renovating a common bathroom, as well as changes that span floors, like installing an elevator or escalator, are also considered building improvements.
Leasehold Improvement Tax Treatment
Between 2001 and 2013, the tax treatment for qualified leasehold improvements changed five times. As of the date of publication, you can depreciate the cost of leasehold improvements over 15 years. Because the rules underlying leasehold improvement depreciation are both complicated and ever-changing, talk to your accountant to find how the current state of the law and how it will affect you.
Building Improvement Tax Treatment
The IRS requires you to depreciate a building improvement over the same time frame that you depreciate your building. Commercial real estate buildings typically have a 39-year life, so it can take a while to recoup the cost of building improvements. With this in mind, if it's possible to classify an improvement as a repair or as a leasehold improvement, you'll achieve more tax savings in the near term.
Section 179 Deduction
Don’t forget about the Section 179 Deduction. This deduction was intended for small businesses. But any business that purchases, finances, and/or leases new or used business equipment during 2018 can deduct the full purchase price of qualifying equipment and software for this tax year. The maximum deduction that can be taken for 2018 is $1,000,000. This deduction is reduced dollar for dollar after you’ve reached $2,500,000. The entire deduction goes away when you reach $3,500,000 in purchases.
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