Tenants who meet certain conditions can get a tax break for TI allowances.
NEW LEASE AGREEMENTS are typically viewed as routine business decisions rather than tax-saving opportunities. Ignorance of rules can prove costly to a tenant who is unaware of the potential tax implications. As an enticement to a new tenant, landlords commonly offer a tenant improvement (TI) allowance to help offset the tenant’s cost of moving into the new space and fitting it to their unique needs. For leases with a term of 15 years or less, there are special tax treatments for these allowances.
Financial Reporting Versus Tax Treatment
For financial reporting purposes, generally accepted accounting principles (GAAP) typically require that an allowance used for property improvements be amortized over the life of the lease. The allowance is also recorded by the tenant as a deferred rent liability and prorated over the life of the lease. For book purposes, then, the tenant is deemed the bona fide owner of the improvements.
If tax rules followed GAAP, the tenant would be required to use a 39-year proper tax life for non-residential real property (or 15 years, if the improvements meet the definition of qualified leasehold improvement property). Moreover, the tenant would also have to recognize the full allowance in gross income when received. Therefore, from a tax perspective, it is far more advantageous for the tenant to have the landlord own the improvements.
By Jeffrey J. Schragg, Partner, BDO USA LLP