Write Off Your Tenant Improvement Costs Faster and Increase After-Tax Cash Flow

Did you know that both landlords and tenants can recover tenant improvement costs much more quickly and improve after-tax cash flow by taking advantage of IRS provisions for accelerated depreciation of tenant improvements via cost segregation?

For landlords, segregating the costs of tenant improvements can be done as part of a project to cost segregate the overall assets in around an entire building. Alternatively, if a building has already been cost segregated, or for a tenant with a large TI investment, tenant improvements can be cost segregated independently of the building containing them. This approach often makes financial sense when the dollar cost of the TIs is large enough (usually $200,000 or more) to justify the cost of a cost segregation study.

How Cost Segregation Works for Tenant Improvements

Cost segregation is a valuable tax deferral strategy for both tenants and landlords who have made or will be making financial contributions towards tenant improvements. Cost segregation studies can be performed in the year the improvements are placed into service or on retroactive basis with a look-back study. Here are some important points to consider if you have invested in tenant improvements:

  • Tenant improvements are a commonly overlooked opportunity for cost segregation.
  • Tenant improvements should not be capitalized over the lease term and must follow the Modified Accelerated Cost Recovery System (MACRS), which for many improvements will result in faster depreciation. The absence of base building elements in cost segregation studies for tenant improvements generally results in a higher percentage allocated to shorter recovery periods than for buildings as a whole.
  • It is important to know which party is depreciating the improvements. Lease language can dictate ownership of specific improvements.
  • Landlords should have costs grouped and summarized by tenant when having a study performed on an entire building to support write-offs during future renovations. That’s because the adjusted depreciable basis of improvements being retired during a renovation can be written-off, if the individual asset costs are known.
  • Large tenant portfolios with similar improvements may be able to benefit from a sampling approach, which can significantly reduce the cost of performing a study.

A cost segregation firm can perform a detailed cost segregation study of the improvements to determine the appropriate recovery periods (5, 7 or 39-year). When improvement costs are shared between the landlord and tenant, it is necessary to allocate costs based on specific ownership and applicable lease language, tenant allowances, or work letters. If there is nothing to document which party owns which assets, then usually it is necessary to allocate based on the percentage contributed by each party to the total improvements costs.

Cost Segregation Studies May Identify Other Missed Write-Offs

If you have missed any of these deductions in prior years then a cost segregation study, properly prepared, will uncover them so that you can claim them on a retrospective basis.
Leasehold improvements made after 9/11/01 may be eligible for special treatment as Qualified Leasehold Improvement Property (QLI). There are specific rules that determine which improvements qualify and there are different levels of benefit depending on the in-service date. For example, in 2008 and 2009, QLI is depreciated over 15 years and can be combined with 50% Bonus Depreciation, which also has special eligibility rules, to further enhance taxpayer benefits. In 2010, QLI is eligible for 50% Bonus Depreciation but is depreciated over 39 years.

An engineering-based cost segregation study is the best way to ensure you achieve the maximum allowable benefits. Rules pertaining to QLI and Bonus Depreciation have been changed numerous times over recent years and are often overlooked or misused. If you have missed any of these deductions in prior years then a cost segregation study, properly prepared, will uncover them so that you can claim them on a retrospective basis.


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About the Author Jeff Glass

Jeff helps real estate owners increase their cash flow. He started his career as a Financial Analyst with the Irvine Company, and worked in various management/executive positions in the mortgage industry for many years. He's been a Cost Segregation consultant for several years and is considered one of the industry's top experts in TPRs. As Director of Business Development for Bedford Cost Segregation, Jeff helps his clients increase cash flow by accelerating their depreciation deductions, and by writing off assets that no longer need to be depreciated under recently changed tax rules. Jeff has a B.S. in Economics from Claremont McKenna College and an MBA with an emphasis in Finance from UC Berkeley.