November 2007 Technical Update

The Tax Relief and Health Care Act of 2006 extended the special statutory 15-year recovery period for qualified leasehold improvement property for two more years, to property placed in service before January 1, 2008. Prior to the passage of this Act, this provision was set to expire on January 1, 2006.

CRS Tip: If any of your clients are currently constructing leasehold improvements, urge them to have them in service by the end of 2007 to take advantage of this provision before it expires.

Qualified leasehold improvement property placed in service after October 22, 2004 and before January 1, 2008 by a lessor or lessee pursuant to the terms of a lease is 15-year MACRS property with a 15-year recovery period. This provision is not elective. In the absence of this temporary provision, these improvements would be treated as 39-year MACRS property.

Qualified leasehold improvement property is any improvement to the interior portion of nonresidential real property that satisfies the following criteria:

• The improvement is made under or pursuant to a lease by the lessee, any sublessee, or the lessor;
• The lease is not between related parties;
• The building (or portion that the improvement is made to) is occupied exclusively be the lessee or sublessee; and
• The improvement is placed into service more than 3 years after the date the building was first placed into service.

Expenditures for the following are not eligible:

• The enlargement of the building;
• Elevators and escalators;
• Structural components that benefit a common area; or
• Internal structural framework.

The applicable depreciation method is the MACRS straight-line method. If the MACRS alternative depreciation system (ADS) is elected or otherwise applies, the recovery period is 39 years and the recovery method is the straight-line method. Whether or not ADS is elected, the applicable convention is the half-year convention unless the mid-quarter convention applies.

A leasehold improvement which is section 1245 property may be separately depreciated over a shorter recovery period (usually 5 or 7 years depending upon the business activity in which the improvement is primarily used) under the MACRS cost segregation rules.