Q & A on the new 30% Bonus Depreciation--Leasehold Improvements
On March 9, President Bush signed legislation designed to stimulate a flagging economy. The bill was somewhat limited in its scope, but its first provision is a version of depreciation relief that the NATIONAL ASSOCIATION OF REALTORS® (NAR) had sought for more than 5 years. NAR and other leading real estate organizations had worked to reduce the recovery period for leasehold improvements from 39 years to 10 years. Congress took a different approach and created a so-called "bonus depreciation" allowance. It permits an additional depreciation deduction for 30% of the cost of investments in leasehold improvements. The Q&A that follows describes the workings of the new rules.
How does the new "bonus depreciation" work?
Assume that a landlord makes improvements costing $100,000 for a tenant. When the improvements are placed in service, the landlord is able to claim a bonus depreciation deduction of $30,000 (30% x $100,000). In addition, that year the landlord may take a deduction for 1/39th of the remaining $70,000. The depreciation schedule then continues based on 1/39th each year for the life for the improvements.
Do the close-out rules enacted in 1996 still apply?
Yes. At the end of the lease, if the leasehold improvement property is abandoned, any balance remaining in the depreciation account may be deducted. Whether property has been abandoned is always a matter of facts and circumstances, and will vary depending on each property.
What is a qualified leasehold improvement?
It is any improvement made to the interior space of a nonresidential building (but not common areas such as elevators or lobbies) pursuant to a lease. The leased area must be occupied solely by the tenant (or subtenant) for whom the improvement is made. Thus, improvements to owner-occupied space do not qualify for the new bonus. In addition, leases made to related parties or affiliated groups will not qualify for bonus depreciation.
Is the bonus available only to landlords?
No. The bonus may be taken by either the landlord or the tenant (or subtenant), but not by both. Agreements for allocating the deduction and paying for the improvements will take place in the ordinary course of negotiating lease terms.
Will buildouts made in a new building qualify for the bonus treatment?
No. The bonus is available only when the building has been in service for more than three years. The purchaser of an existing building that is more than three years old will qualify for the bonus depreciation for leasehold improvements made pursuant to leases entered into after purchase.
Will enlargements of the building qualify for the bonus?
No. Further, the bonus is not available for improvements to the internal structural framework of a building. That framework will continue to be treated as 39-year real property.
Is the new provision permanent?
No. It is available only for leasehold improvements made after September 10, 2001 and before September 11, 2004.
Are there any binding contract rules?
Yes. In order for property placed in service after September 10, 2001 to qualify for the bonus, the contract for its construction must have been signed after September 10, 2001. If property is contracted for but not yet placed in service as of September 11, 2004, the bonus will continue to be available, so long as the property is placed in service before January 1, 2005.
Does any other property qualify for the bonus depreciation?
Yes. The bonus depreciation allowance is available for all depreciable property with a life of 20 years or less. Thus, most equipment qualifies for the bonus. In addition, an additional allowance of $4,600 is available for automobiles used in a trade or business. The car must have been acquired and placed in service under the binding contract rules above to qualify for the bonus.
Will this new incentive sweep me or my business into the alternative minimum tax (AMT)?
No. Congress specifically provided that the bonus depreciation allowance would be available in computing both regular and AMT liabilities.
Is Congress likely to extend the provision when it expires in 2004?
It's too soon to tell. However, the fact that so much equipment qualifies for the bonus will have the effect of broadening the coalition of businesses that will press Congress in the coming years for a review of the entire depreciation system.
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