You would think a simple thing like how to depreciate leasehold improvements would an easy thing to answer. Unfortunately, Congress has made it a very complex matter. There is no one, single method for depreciating leasehold improvements. And there is no one single number of years in which the life of leasehold improvements (L/I) may be depreciated.
For example, depending on the facts and circumstances, L/I may be required to be depreciated under the straight line method, or eligible for 50% bonus depreciation, or eligible for 100% bonus depreciation or eligible to be expenses (called section 179 Depreciation Method). Further, a L/I may be required to be depreciated over 39 years, or 15 years or 1 year.
Why? Why has such a simple matter as depreciating L/I become so complex? 2010 tax legislation is interfering with other tax pre-2010 tax legislation and made a mess of things. in 2010 alone there were six major pieces of tax legislation, the last one being the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 (2010 Tax Relief Act) (P.L. 111-312), which was passed on December 17, 2010.
Tom Corley to the rescue. I will, as usual, turn the incredibly complex into the incredibly simple. So simple that even Forest Gump would be able to understand. So here we go….
How to depreciate leasehold improvements:
1. Expense 100% of your L/I in one year – You may qualify for what they call section 179 expensing on qualified leasehold improvements. In order to qualify you cannot simultaneously be the landlord and the tenant (called the “related party rule”), you must have a profit, your deduction is limited to your profit, your deduction cannot exceed $500,000 and the L/I must be any improvement to an interior part of a building that is nonresidential real property in the United States, if all the following requirements are met:
The improvement is made under or according to a lease;
* That part of the building is to be occupied exclusively by the lessee;
* The improvement is placed in service more than 3 years after the date the building was first placed
in service by any person;
* The improvement is section 1250 property (think “real estate property” as opposed to computers,
furniture etc);
A qualified leasehold improvement does not include any improvement for which the expenditure is attributable to any of the following:
* The enlargement of the building;
* Any elevator or escalator;
* Any structural component benefiting a common area;
* The internal structural framework of the building.
2. Expense 100% of your L/H in one year – You may qualify for what they call 100% Bonus Depreciation. In order to qualify you cannot simultaneously be the landlord and the tenant (called the “related party rule”), the improvements were made after September 8, 2010 and before January 1, 2012 and the improvements were “qualified leasehold improvement property” (see definition above);
3. Expense 50% of your L/H in one year – You may qualify for what they call 50% Bonus Depreciation. In order to qualify you cannot simultaneously be the landlord and the tenant (called the “related party rule”), the improvements were made in 2010 and the improvements were “qualified leasehold improvement property” (see definition above);
4. Straight line depreciation over a 15 year period for “qualified leasehold improvement property” (see definition above). In order to qualify you cannot simultaneously be the landlord and the tenant (called the “related party rule”), the improvements were made in 2009 or 2010 and the improvements were “qualified leasehold improvement property” (see definition above);
5. Straight line depreciation over a 39 year period for normal L/I property that does not qualify under items 1 through 4 above. This default rule is required in instances where you are both the landlord and the tenant of the leased property. In these cases L/Is can never be treated as qualified L/I property. To make things even simpler for you, always assume your leasehold improvement must be depreciated under the straight line method over 39 years unless it meets the definition of “qualified leasehold improvement property” in which case this 39 year general rule would not be required to apply.