Landlords Seek Relief on Improvement Costs
by Ray A. Smith, The Wall Street Journal
Owners of commercial real estate would get more bang for their buck under a proposal to allow them to recoup a greater amount of expenses from tenant improvements in less time.
Legislation introduced earlier this month in the House and last month in the Senate calls for amending the Internal Revenue Code to allow landlords to depreciate so-called leasehold improvements made to the space a tenant occupies over 10 years, rather than the current 39-year period. The proposal covers commercial real estate, including shopping centers, office buildings and motels, but not apartments, where landlords don't have to reconfigure space to meet tenants' needs.
The legislation was sponsored in the Senate by Sen. Kent Conrad, a Democrat from North Dakota, and in the House by Rep. E. Clay Shaw, a Republican from Florida. Spokespersons for both say the legislators plan to attach the amendment to a tax plan, but haven't yet determined which one. President Bush's tax-growth package hasn't been ruled out.
Under the current law, an owner who spends $1,000 on improvements for, say, a tenant with a 10-year lease, could only deduct 1/39 of the expense when filing his or her taxes each year for 39 years, even though the life of those improvements tend to be much shorter. The Real Estate Roundtable, one of the industry groups that pushed for the amendment, says lease terms are typically five to 10 years.
But under the amendment, that owner could deduct 1/10 annually for 10 years, recouping the investment much faster.
"This will save owners money," says Stefan F. Tucker, a partner at the law firm Venable LLP, Washington, D.C., who worked with the roundtable on proposed language for the amendment. "They'll be able to take a write-off of the actual costs [of improvements] sooner. And instead of 2.5% annually, it will be 10%."
What's more, some real-estate tax lawyers say the change would encourage owners to make more improvements more quickly.
"Let's say you're in retailing," says Fred Witt, national director, real-estate tax services, in the Phoenix office of Deloitte & Touche LLP. "There's a lot of pressure on keeping tenant improvements up to date and fresh and trendy."
Improvements to a tenant's space can include anything from lighting fixtures to electrical wiring to plumbing to roofing. Landlords have long been able to claim deductions for leasehold improvements. But the 10-year time frame would be the fastest depreciation since the Economic Recovery Tax Act of 1981. That act set both the useful lives of buildings and building improvements at 15 years, from a cumulative average of 18 to 20 years. That number rose again, however. Following the Tax Reform Act of 1986, the term was increased to 31.5 years. In 1993, it was raised to the current 39 years.
Tax lawyers say the increase was an apparent attempt by the federal government to conserve revenue by allowing real-estate owners to deduct less and less.
"Because of turnovers of leases and because of obsolescence, leasehold improvements don't last 39 years," says Stephen M. Renna, senior vice president and counsel at the roundtable. "It doesn't make sense to depreciate leasehold improvements over 39 years when their actual life is much shorter."
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