Qualified Real Property

Depreciation can be a confusing topic, especially as a property owner. The IRS establishes multiple lives and methods for depreciating assets, making it frustrating and seemingly impossible to determine which life to assign and/or what method to use. Especially confusing can be all the different qualified real property categories and under what circumstances each applies. It’s important however to understand the differences between each category, especially since the Protecting Americans from Tax Hikes (PATH) Act of 2015 created a new category of 39-year property subject to bonus depreciation. The subtle differences in each of the categories allow for opportunities which companies may not yet be exploiting.
The following article gives a closer look at each of the categories. For a quick summary and reference guide, see the table at the end of this blog post.

Qualified leasehold improvement property

Generally, this is any improvement to an interior part of a building that is nonresidential real property*. The following requirements must be met in order for property to be considered qualified leasehold improvement property:

  • The improvement made was made pursuant to a lease by the tenant, sub-tenant or the landlord to a part of the property to be occupied exclusively by the tenant (or sub-tenant).
  • The improvement is placed in service more than three years after the date the building was first placed in service (by any taxpayer).
  • The expenses are not for the enlargement of the building, any elevator or escalator, any structural components benefiting a common area or the internal structural framework of the building.
  • The lease is not between related parties**.

Leasehold improvements that meet the above criteria qualify for a 15 year MACRS recovery period (made permanent by PATH), are eligible for special bonus deprecation and are eligible for Section 179 deduction***.

At first glance, one of the disqualifying bullet points (“structural components benefitting a common area”) would seemingly disqualify many leasehold improvements from utilizing the shorter 15-year life. Don’t let this requirement deter you right away! A deeper look at the regulations surrounding this requirement will show less restriction than you might assume.

Qualified restaurant property

This is any Section 1250 property****  that is a building or an improvement to a building if more than 50% of the building’s square footage is devoted to preparation of, and seating for on-premises consumption of, prepared meals. Qualified restaurant property placed in service before Jan. 1, 2016, is not eligible for bonus depreciation unless the improvements also satisfy the definition of qualified leasehold improvement property.
Qualified restaurant property has a 15 year MACRS recovery period (made permanent by PATH), is not eligible for special bonus depreciation (exception noted previously), but is eligible for Section 179 deduction.

Qualified retail improvement property

This is generally any improvement to an interior portion of a building that is nonresidential real property. The following requirements must be met to meet definition of qualified retail improvement property:

  • The improvement portion of the building is open to the general public and is used in the retail business of selling tangible personal property to the general public.
  • Such improvement is placed in service more than three years after the date the building was first placed in service.
  • The expenses are not for the enlargement of the building, any elevator or escalator, any structural components benefiting a common area, or the internal structural framework of the building.

Examples of these retail establishments include grocery stores, clothing stores, hardware stores, and convenience stores.
After Dec. 31, 2015, retail improvements are, by definition, bonus-eligible because they are also qualified improvement property. Prior to PATH, qualified retail improvement property was  not eligible for bonus depreciation unless the improvements also satisfied the definition of qualified leasehold improvement property.
Qualified retail improvement property has a 15 year MACRS recovery period (made permanent by PATH), is eligible for special bonus depreciation as of January 1, 2016 (see above paragraph) and is eligible for Section 179 deduction.

Qualified improvement property (QIP) (NEW!)

This new category is, in essence, simply an amendment to the qualified leasehold improvement property requirements, except that the changes only impact whether a taxpayer qualifies to take bonus depreciation.  QIP must meet the same requirements as Qualified Leasehold Improvement Property except for the following in order to qualify to take bonus depreciation

  • The improvement made was made pursuant to a lease by the tenant, sub-tenant or the landlord to a part of the property to be occupied exclusively by the tenant (or sub-tenant).
  • The improvement is placed in service more than three years after the date the building was first placed in service (by any taxpayer).
  • “common area” restriction

It’s important to note that improvement expenditures attributable to the enlargement of the building, any elevator  or escalator, or the internal structural framework of the building are still excluded from taking bonus depreciation and are considered 39 year property under MACRS. That said, think of this new category as a sort of expansion on the other 3 categories, meaning qualified improvement property has a 39-year recovery period unless it also meets the definition of either qualified leasehold improvement property, qualified retail improvement property, or qualified restaurant property. For example, say your improvement expenditure meets all the qualifications of qualified leasehold improvement property, in this case you will get all the benefits of such (shorter life, bonus depreciation, etc.). On the flip-side, say your improvement expenditure does not meet all the requirements of qualified leasehold improvement property but does meet the requirements of qualified improvement property, in this case the depreciable life will still be the longer 39 years, but you will now be eligible to take bonus depreciation.

Quick Reference Guide

Qualified Real Property Table

 

For more information on qualified real property, get in touch with Eric Bell or Joseph Lewis of Isler CPA.

 

*IRS Section 856(c)(5)(C) indicates that real property means “land or improvements thereon”

**Related parties include taxpayers and their spouses, parents, grandparents, children, grandchildren and siblings. Taxpayers are also considered related to certain entities that they own (directly or indirectly) 80% or more of.

***Section 179 allows taxpayers to expense certain property in the year placed in service. Certain qualifications must be met.

****Section 1250 property includes all real property that is subject to an allowance for depreciation that is not and never has been section 1245 property