A property owner may rent out his space to a tenant, and in the negotiation of the lease of such a space, it will often be discussed what are the types of improvements that would need to be made in order for the renter (the lessee) to move into and use the space. Therefore, leasehold improvements must be made to the space by the renter (the lessee) even though the landlord (the lessor) owns the space. The lessee will use these improvements throughout the life of his lease agreement, and then the improvements will then normally become the property of the landlord (the lessor).
Therefore, leasehold improvements are any improvements made by the lessee who is renting from the lessor and for which the lessee will use throughout the life of the lease agreement. The lessee is the owner of these improvements until the expiration of the rental contract.
For accounting purposes, improvements of these leased spaces should be capitalized and amortized over the life of the lease or over the life of the improvement. (For each different improvement types, you would use the life that is shorter. For example, if one of the improvements in the space was to install new flooring, it is possible that the depreciable life of that floor would be less than the lease term.)
Qualified Leasehold Improvements (QLI)
Not everyone knows that there is tax law that may allow a building owner to find significant tax savings for their leasehold property. Any leasehold improvements made to an interior portion of a building after 2004 may qualify for 15 year straight line depreciation, and it may additionally qualifies for bonus depreciation if it was placed in service after December 31st of 2007. This is true of nonresidential properties only. However, these leasehold improvements only qualify for the 15 year straight line and bonus depreciation if they occurred more than three years after the original building was placed in service, and the improvements were done by unrelated parties. There are certain improvements to the interior of the building that are excluded from QLI, and it should be noted that the benefit of these tax savings would go to the entity that paid for these improvements.
Qualified Improvement Property (QIP) vs Qualified Leasehold Improvements (QLI)
While there are many advantages to being able to use QLI, there may be times when it would be more beneficial to use QIP (Qualified Improvement Property). Also, what if you do not qualify for QLI because of the three year rule or because a related party was involved with the improvements to the property? In cases such as these, there is a new opportunity created in 2016 that is called Qualified Improvement Property (QIP). QIP also pertains to improvements made to the interior portion of a building, just like QLI. However, it is not necessary that you have to wait three years after the placed in service date, nor that the parties be unrelated. The qualified improvement property will be depreciated over 39 year straight line instead of 15 year straight line, but it is also bonus depreciation eligible. This means that you can write off a large amount of your depreciation in your first year and find significant tax relief right away.
How do I know which one is right for my situation?
It can be very helpful to talk with someone who has been working with these kind of situations for many years. If you own commercial property, and have questions about QLI and QIP, then give the professionals at Ernst & Morris a call. We have been in the business of accelerating the depreciation of tangible and real property assets for over 25 years. (This process is called cost segregation) If you have any questions at all, please call us at 1-800-COSTSEG.
- Cost Segregation
- The Industry
- Who Qualifies
- Typical Reallocations
- 1031 Exchanges
- Depreciation Overview
- Accelerated Depreciation
- MACRS Depreciation
- Qualified Improvement Property
- Leasehold Improvements
- 1245 Property
- Residential Real Estate
- In-House Presentations
- Partnership Opportunities