Looking to Remodel? You Can Benefit From a Number of Tax Breaks
Thinking about fixing up, remodeling or redecorating your facility or store? Naturally, you’ll want to keep out-of-pocket expenditures to a minimum and recover as much of the funds spent as quickly as possible. Fortunately, retail shop and tennis facility operators who own their buildings and those who lease their property can take advantage of a variety of tax deductions, credits, and other tax breaks to achieve those goals.
Additions and improvements are usually depreciated in the same manner as the existing property would be depreciated. For instance, a roof replaced on a commercial building is usually treated as 39-year nonresidential real property, regardless of how that building actually is written-off or depreciated. But in many cases, improvements, additions, or remodeling could qualify for faster — and larger — write-offs, even a direct reduction of your business’s tax bill.
First, consider the unique, new, faster write-off for so-called “leasehold improvments” created by the American Jobs Creation Act of 2004. The law created a 15-year recovery period for “qualified leasehold improvement property” placed in service between Oct. 22, 2004, and Jan. 1, 2006. This write-off is not optional. The new law temporarily reduces to 15 years the depreciation period for improvements made to leased business property (and qualified restaurant property).
Qualified leasehold improvement property is an improvement to the interior portion of a building that is nonresidential real property — provided certain requirements are met. The improvement must be made pursuant to a lease either by the lessee (or sublessee) or by the lessor. The lessee and lessor cannot be related, the original building must be more than 3 years old, and the improvement must be made to that portion of the building occupied exclusively by the lessee or sublessee.
Expenditures for the enlargement of a building, any elevator or escalator, any structural component that benefits a common area, or the internal structural framework of the building do not qualify. However, since a lessee does not usually retain the improvement upon termination of the lease, a loss normally results. A lessor that disposes of or abandons a leasehold improvement when the lease ends may use the adjusted basis of the improvement to determine its gain or loss.
Thanks to a special exception in the rules, the 30- or 50-percent “bonus” depreciation allowance is available for “qualified leasehold improvement property” placed in service before Jan. 1, 2005.
Divide for a Larger Write-Off
The IRS permits some elements of a building to be separately depreciated as personal property, versus items that are considered structural components (i.e., real property). This “cost segregation” provides for a shorter recovery period for the personal property elements. (Structural components could include items such as boilers, ceilings, cental air conditioning and heating systems, chimneys, doors, electrical and wiring, fire escapes, floors, hot water heaters, HVAC units, lighting fixtures, paneling, plumbing, roofs, sinks, sprinkler systems, stairs, tiling, walls and windows).
Expenditures for other “improvements,” not structural components and not related to the operation of the building, can often now be separately written-off using much shorter recovery periods. In fact, many of those “personal property” items may qualify for the first-year (Section 179) expensing deduction and be immediately expensed. To qualify, the property must be tangible Section 1245 property, depreciable and acquired by purchase for use in the active conduct of a trade or business.
The first-year expensing allowance can include many Section 1245 personal property costs, but only to certain limits. For instance, a retailer or facility operator can currently expense up to $100,000 in Section 179 expenditures every year. Should total expenditures for Section 179 property exceed $400,000 in any year, the deduction must be reduced dollar-by-dollar by any excess.
Rehabbing vs. Fixing Up
There’s also a unique tax credit that can reduce your tax bill for incurring “rehabilation expenditures.” The rehabilitation investment tax credit equals 20 percent of the qualified rehabilitation expenses (QRE) for certified historic structures and 10 percent of QRE for qualified rehabilitated buildings first placed in service before 1936.
A building and its structural components constitute a qualified rehabilitated building if they are (1) substantially rehabilitated and (2) placed in service before the rehabilitation begins. Property other than a certified historic structure must also satisfy (3) a “wall retention” test, (4) an age requirement, and (5) a location of rehabilitation requirement. Property is considered substantially rehabilitated only if the expenditures during a self-selected 24-month measurement period (60-month period for phased rehabilitation) are more than the greater of the adjusted basis of the property or $5,000.
QRE does not include new construction; an enlargement; the cost of acquisition; noncertified rehabilitation of a certified historic structure; rehabilitation of tax-exempt use property; expenditures, generally, that are non-depreciable; and lessee-incurred expenditures if, on the date the rehabilitation of the building is completed, the remaining term of the lease (without regard to renewal periods) is less than the property’s recovery period.
Energy Investment Credit
Another unique tax credit — a direct reduction of the racquet sports operation’s tax bill rather than a deduction from the income upon which that tax bill is computed — is available for so-called “energy” property. The business energy investment credit is equal to 10 percent of the basis of energy property placed in service during the year. (No energy credit is allowed for that portion of the basis of property for which rehabilitation investment credit is claimed.)
Energy property includes equipment that uses solar energy to generate electricity, to heat or cool a structure or to provide solar process heat. It also includes equipment that produces, distributes, or uses energy derived from geothermal deposits, with some restrictions. To qualify for the credit, the equipment must be depreciable (or amortizable) and must meet performance and quality standards. No partial deductions are available, so a retailer or facility operator must complete the construction, reconstruction, or erection of the property. If the property is acquired, your business must be the first to use it.
Fixing Up Land
The cost of the land upon which your business sits is not deductible, but fortunately, improvements made to that land can often qualify for a tax deduction. Land improvements not specifically included in any other asset class and otherwise depreciable are 15-year property. Examples of land improvements include sidewalks, driveways, curbs, roads, parking lots, canals, waterways, drainage facilities, sewers (but not municipal sewers), bridges, and nonagricultural fences.
Regardless of whether your business premises are owned or leased, there are an abundance of tax deductions, credits and unique write-offs available to help offset the cost of remodeling, fixing up, or adding to it.
The new, but temporary, 15-year write-off for leasehold improvements applies only to improvements placed in service before Jan. 1, 2006. But fortunately, many other tax credits, deductions, and write-offs constitute a more permanent part of our tax laws. The question is, will you take full advantage of this unique helping hand?
See all articles by Mark E. Battersby
About the Author
Mark E. Battersby is a tax advisor and author in Ardmore, Pa.