Cost Seg Building

A Blog About Tax Savings for Building Owners

Tag: Tenant Improvements

Are You Overpaying the IRS? The Case for Cost Segregation on Tenant Improvements

September 26, 2024 /

Should you do cost segregation on tenant improvements? Most tax advisors and CPAs don’t bother. They just call it QIP (qualified improvement property) which gets a 15 year class life. If it’s 80% bonus as it was in 2023, they just claim 80% in year 1. If it’s in 2024, then it’s 60% and they take 60% bonus in year 1. But did you know that more often then not, the owner of those tenant improvements is paying more money in taxes than they need to be?

If you consider that with a lot of improvements, the 5 year class life will be 25 – 45% of the overall improvement, then it means there’s still more to squeeze out. Consider this scenario…$400,000 tenant improvement. Let’s say that 35% of that would get identified as 5 year class life. If it goes into service in 2024, the tax advisor or CPA is going to take 60% of $400,000 or $240,000 in year one for the deduction. However, $160,000 in depreciation remains and that will be deducted over the next 14 years. But in that $160,000, we said 35% is 5 year class life. 35% of $160,000 is $56,000. So you might now have $56,000 that you could have taken over the next 4 years now lumped together with the 15 year QIP and it gets spread out over 14 more years. For those keeping track, a $56,000 tax deduction at a 32% tax rate is about $18,000 in taxes. So in other words, you are paying $18,000 to the IRS that could have stayed in your bank account over the next 4 years. Yes, there will be those who say it all works out at the end of the day so why am I bringing this up? Sure, it works out over 15 years but you miss out on the opportunity to keep more of your money working now than bleeding it out over 15 years.

If you made improvements north of about $200,000 in 2024, those should be studied. You should at least have it evaluated. Some of those improvements will be able to take partial asset disposition (PAD). That’s a use it or lose it tax strategy. Pretty much most owners miss out on this deduction. They miss out be they are not engaging nor are their tax advisors and CPAs with cost segregation professionals with every single improvement over $200,000. If I had to guess, I would think that somewhere between 97-98% of all improvements over $200,000 are not studied. And they should be.

If you’re okay paying the IRS $5, $10, $15, $20k more than you need to be, no problem. But if you want to squeeze everything out of your building and improvements that you are lawfully allowed to do, then have me run your project through this calculator to see. Every building owner I talk with tells me that they don’t want to pay any more in taxes than they absolutely have to. So why then are you paying more in taxes than you have to? I also hear a lot of building owners that the wish they got more tax strategy from their tax advisor. Okay, tax advisors, here’s a fantastic, easy, cost-effective and inexpensive way to be strategic for your clients.

Got Tenant Improvements? Let’s run them through my model and see what it spits out.

I’ve built a custom calculator to help figure out if it’s worth it or not to do cost segregation on improvements. It’s very details and gives you some tolerances and ranges so you can see if it’s worth it or not. I’ve played around with it and I can tell you that nearly all these capital improvements, tenant improvements, renovations etc. can benefit from cost segregation.

Below is a brief video I recorded demonstrating this calculator. All CPAs, EAs, and tax advisors should run their client’s projects through this model.

Connect with me on LinkedIn or give me a call. My contact information is below. I’d be happy to discuss your project anywhere in the U.S. I can run your project throught this Tenant Improvements calculator and see what kind of results we might expect. Let’s maximize your tax savings on your building, project, improvements.

John Murphy CSSI

Maximizing Tax Savings: The Overlooked Benefits of Cost Segregation for Tenant Improvements

July 8, 2024 /

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.

#tenantimprovements #Tis #renovations #commercialrealestate #CRE #brokers #CREbrokers #GCs #generalcontractors #buildingowners #CPAs #taxsavings #taxbenefits #depreciation #bonusdepreciation #accelerateddepreciation #recapturetax

Understanding the Impact of Tangible Property Regulations on Landlords and Tenants: Capitalization vs. Expense Deduction for Tenant Improvements

March 13, 2023 /
Tenant Improvements – Photo Credit John Murphy, Cost Seg Building

Are you looking to do tenant improvments (TIs) to your building? Are you aware that the Tangible Property Regulations (TPRs), i.e. repair regulations, are to your benefit as a building owner? There are specific guidelines to help building owners save money on their taxes when it comes to TIs. Many times we see that owners have capitalized items that could have been expensed. Not only is that the incorrect way to account for some items, the IRS doesn’t want you to do it that way and it’s costing you quite a bit in lost tax savings.

The words lessee and lessor in §1.162 and §1.263(a) (Tangible Property Regulations) are mentioned over 200 times. The TPRs are a dramatic change for landlord and tenants regarding the capitalization or expense deduction of tenant improvements.

There are two critical general rules under §1.263(a) for leased property and improvements.

The first general rule is that an improvement to a unit of property is NOT a separate unit of property from the building. The second general rule is if the landlord’s expenditure is NOT a restoration, adaptation, betterment, or improvement (RABI), then it is repair and maintenance.
The unit of property for a taxpayer who is the lessee of an entire building is each separate building, its structural components, and building systems.

If the lessee leases only a portion of a building (such as an office, entire floor, or specified square footage), the portion of each building and the building systems associated with ONLY the leased portion is the unit of property. If the lessee pays for the tenant improvements, the lessee must generally capitalize the related amounts, which it pays to improve the tenant space. The only exception is if §110 applies. §110 is a construction allowance received by the lessee for the sole purpose of the improvement or when the improvement constitutes a substitute for rent.

In other words, tenants who do not lease the entire building and pay for their tenant improvements have their separate unit of property, and those improvements must be capitalized under the UNICAP rules §263A.

If the landlord pays for the tenant improvements, they must be put through the RABI rules (restoration, adaptation, betterment or improvement) to determine if the tenant improvements are a repair and maintenance item or if they must be capitalized. Generally, an amount capitalized as a tenant improvement is not a separate unit of property from the building. If the landlord’s tenant improvements are not a separate unit of property from the building, the landlord can compare the expenditure against the whole building, building structures, and building systems. The result will be that most landlord tenant improvements, (beyond the initial tenant improvements capitalized for each space), will be classified as a repair and maintenance expense.

Example

The landlord owns and operates two buildings. One is a 4-story office building of 40,000 square feet with the first floor consisting of retail space. The other building is a stand-alone 10,000-square-foot retail building. The landlord has two new tenants move in 2022. Tenant A leases the first floor of the 4-story building. Tenant B leases the stand-alone building. The landlord already had prior tenants in those spaces and has tenant improvements on its books for both of those building spaces. The landlord tears out the previous tenant improvements and does extensive new tenant improvements for both tenants.

Conclusion

The landlord can expense the tenant improvements for Tenant A in the office building but must capitalize the tenant improvements for Tenant B. The reason he can expense the TIs for the office building is that the space being renovated consists of only 25% of the building. The Tangible Property Regulations allow that if you are improving less than 30-35% of the building that those costs might be able to be expensed instead of capitalized. However, we will often see that owners have indeed capitalized such items.

Regarding Tenant B, the landlord must capitalize those improvements because because it’s 100% of the property. However, they can do a partial asset disposition (PAD) and get a significant tax deduction for the removal of those previous tenant improvements that had been in the building. PADs must be completed in the tax year in which the work (improvement / renovation) was done.

So what’s the difference between these two buildings? The landlord replaced a large physical portion of the stand-alone building that B occupied but only improved 25% of the building that tenant A was to occupy.

If you are a building owner and you are doing tenant improvements, reach out to consult with me at no charge. We can discuss your situation and see if it makes sense to expense or capitalize your improvements and whether or not it might qualify for a partial asset disposition.

The original article appeared on CSSI’s website and has been updated here at Cost Seg Building.

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