We are now accustomed to late-year federal tax law changes.
The Protecting Americans from Tax Hikes Act was another of those laws passed late in 2015 that brought important changes for commercial property owners and tenants alike. The law made permanent the special depreciation life for leasehold improvements.
For 2015 and future years, leasehold improvements are depreciated over a 15-year life using the straight-line method. Based on prior law, commercial building improvements were depreciated over a 39-year life for tax purposes.
Prior to the PATH Act and also for 2015, qualified leasehold improvements had to meet several criteria.
The new law simplifies these criteria for improvements that qualify for accelerated depreciation. Gone are the requirements for a lease or that the building be at least 3 years old. The improvements are no longer precluded from benefiting the common area. Changes simplify the rule and also broaden the possibilities for landlords and tenants.
Another major win in the PATH Act was a long-term extension of bonus depreciation.
Bonus depreciation was extended at 50 percent for 2015 through 2017, 40 percent for 2018 and 30 percent for 2019. For 2015, qualified leasehold improvement property is eligible for bonus depreciation. For 2016 through 2019, qualified improvement property is also eligible for bonus depreciation. For example, a landlord completing $100,000 of qualified tenant improvements in 2016 can immediately deduct $50,000 of the improvements.
Now, determining who owns the building improvements – the tenant or the landlord – is a complicated question. Typically, landlords depreciate the tenant improvements if they are paying for them. If tenants pay for the improvements, they will normally depreciate the improvements. Lease arrangements are unique, so consult an attorney regarding who owns the real property improvement before proceeding.
The PATH Act also extended another benefit called the 179D deduction.
It allows building owners to expense up to $1.80 per square foot for new energy-efficient property placed in service in 2016. The owners can take the deduction in one of two ways:
1. A maximum of $1.80 per square foot for an entire building, if it exceeds energy-reduction thresholds.
2. Up to 60 cents per square foot for each of the following systems that exceed energy reduction thresholds: heating, ventilation and air conditioning; lighting; and building envelope.
The PATH Act requires the use of 2007 standards by the American Society of Heating, Refrigerating and Air-Conditioning Engineers to determine the amount of energy savings in a building to qualify for the 179D deduction. It does require an energy study.
Finally, landlords and tenants should consider whether the improvements are even required to be capitalized. The IRS finalized new tangible property rules and regulations in the past few years. There are many opportunities for property owners to deduct building improvements as repairs and routine maintenance. The IRS raised the minimum threshold level to $2,500 spent per item for most taxpayers.
While the PATH Act came late in the year, it certainly provides some big benefits for building owners and tenants.
Derek Smith is a director with BKD LLP. He can be reached at dereksmith@bkd.com.
