Until 2004, the Internal Revenue Code required that depreciation for qualified leasehold improvements occur over the economic life of the building structure itself — 39 years — rather than over the economic life of the improvements. In 2004, tax legislation was enacted that temporarily reduced this 39-year depreciation period to 15 years — a period more reflective of the true economic life of Ieasehold improvements in the modern commercial real estate market. From 2004 until December 2015, 15-year qualified leasehold improvement depreciation was subject to expiration, depending on annual or biannual renewals by Congress in so-called “tax extenders” legislation. This lack of permanency contributed to unpredictability for developers, owners, and those who would invest in commercial real estate. Finally, with the enactment of the "Protecting Americans from Tax Hikes Act of 2015" in December 2016, NAIOP achieved a long-sought goal of making 15-year leasehold improvement depreciation a permanent fixture of the tax code.
The length of time over which assets may be depreciated is important for real estate development and investment. Longer depreciation periods result in higher capital costs to building owners, creating disincentives for them to upgrade and modernize space for their tenants. An owner of a building making qualified leasehold improvements valued at $100,000 as part of a lease agreement, for example, would recover that investment over 15 years by expensing nearly $6,700 annually (1/15th of $100,000). However, if depreciation is spread out over 39-years, then the owner can only recover approximately $2,600 annually of the amount spent on these improvements (1/39th of $100,000) — a cash flow decrease of $4,100 in one year. In other words, an owner recovers his $100,000 investment in qualified leasehold improvements at a rate 2.5 times faster under the 15-year depreciation rules when compared to a 39-year depreciation schedule.
How businesses depreciate assets will be a control element of tax reform discussions. NAIOP strongly supports the principle that depreciation periods for assets should never exceed the true economic life of the asset.
The 15-year leasehold improvement depreciation provision was made permanent by the "Protecting Americans from Tax Hikes Act of 2015". Depreciation schedules are expected to become issues in tax reform discussions in 2017.
"Protecting Americans from Tax Hikes Act of 2015"
Tax Increase Prevention Act of 2014 (H.R. 5771)
Economic Impacts of Commercial Real Estate, 2014 Edition , Submitted by: Stephen S. Fuller, PhD Dwight Schar Faculty Chair and University Professor; Director, Center for Regional Analysis, George Mason University, Arlington, Virginia
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