Tenant Improvements and Cost Segregation
Tenant Improvements, or TI’s as they are known typically are not studied. If it’s an interior improvement to a building most CPAs will just mark this cost as QIP or Qualified Improvement Property. It has a 15 year class life just like land improvements do. In the world where bonus depreciation was 100%, I could see why they would do this and not study the improvements. I still think there are benefits to studying the improvements even at 100% bonus but I’ll make mention of that in a minute.
But here we are today at 60% bonus depreciation. In 2023, bonus depreciation was 80%. Pretty much all hope has faded at this point that 100% bonus depreciation is coming back in 2024. Speculation is that the new government in 2025 will renew 100% bonus depreciation for 2025 and beyond but no one knows for sure at this point. All we have is 2024 and we sit at 60% bonus depreciation.
When I talk with CRE brokers about TI’s they will often tell me it absolutely makes sense that TI’s have a shorter class life at 15 years because pretty much once those improvements are made for a particular tenant, they are often worthless to the building owner when and if he has to place a new tenant in the space. Usually they have to tear it out or significantly modify the space for the new tenant. So the improvements have zero value essentially. When I talk with GCs who actually build out these TI’s they often say the 5 year class life property often has to be updated anyway in 5 years. It’s often worn out or maybe outdated. If that’s the case, why not identify and reclassify your TI’s so that you can clearly see what is 5 year property?
What is interesting is that if you actually study tenant improvements, the results will often come back with 30, 40, 50, 60% of the work effort being identified as 5 year property. The result usually is QIP…sometimes there ends up being some structural at 39 years. But lets say the 5 year is 50% of the overall improvement? That is significant in terms of depreciation, tax savings, diminished value and recapture tax. After seeing what I’m seeing on many TI projects, I’m really surprised owners don’t have these efforts cost segregated. The reason they don’t have them studied is their CPAs tell them they will just take 60% bonus and identify it all as 15 year. While that is an accepted practice, the owner is leaving depreciation on the table by not breaking out the 5 year. Some will say it’s not worth the cost of the study. To study most Tis is only a few thousand dollars. It absolutely is worth it for the owner to study it.
Given the space limitations here, I’ll do a follow up post at some point with some further details. But TI’s are not unlike the broader issue with commercial property…why would you buy a commercial property which is made up of 5, 15, and 39 year property but leave it all as 39 year property and depreciate it as such? There are on a few circumstance where that makes sense to do so.
Commercial real estate brokers and General Contractors have a real opportunity here to help their clients maximize their tenant improvements and get all the tax benefits they can out of improving their buildings.
I work all over the U.S. If you’d like to have a conversation, please don’t hesitate to reach out to me. You can also follow me on Twitter @costsegbuilding or visit my blog for more detailed information about cost segregation at www.costsegbuilding.com.
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