OUR THOUGHTS ON:

Know the Tax Considerations for a Construction Allowance in Your Lease

Real Estate|Retail|Tax

By Carl Scharf

The negotiation of the construction allowance is an important part of a lease transaction; however, those negotiations rarely consider the tax consequences.  The tax treatment of the construction allowance can greatly impact your negotiations.

Landlord-Owned Improvements
When a landlord provides a cash allowance to a tenant to construct leasehold improvements that the landlord will own, the tax treatment is straightforward.  The landlord must depreciate the improvements over an unfavorable 39-year period applicable to nonresidential real property, even if the lease term is less than 39 years.  Since the tenant is merely a conduit for the landlord’s cash, the cash received is not treated as income, and the tenant is not allowed to capitalize and depreciate any of the improvements.

Tenant-Owned Improvements
When the tenant owns the leasehold improvements, the landlord can amortize the allowance as a deduction ratably over the lease term.  Since the tenant owns the improvements, the cash received is taxable income because it “enhances the tenant’s wealth” by enabling the tenant to construct suitable facilities.  The tenant must then depreciate the leasehold improvements over their proper useful life.

In summary, the tax treatment of a construction allowance largely depends on who owns the improvements.  To further complicate matters, the IRS has a benefits and burdens ownership test that helps taxpayers make this key determination.  “Tax ownership” is not always the same as legal ownership.  If you are negotiating a construction allowance as part of your lease and need help understanding the tax complexities, please contact your Schneider Downs representative for further assistance and information.

© 2014 Schneider Downs. All rights-reserved. All content on this site is property of Schneider Downs unless otherwise noted and should not be used without written permission.

This advice is not intended or written to be used for, and it cannot be used for, the purpose of avoiding any federal tax penalties that may be imposed, or for promoting, marketing or recommending to another person, any tax related matter.

Material discussed is meant for informational purposes only, and it is not to be construed as investment, tax, or legal advice. Please note that individual situations can vary. Therefore, this information should be relied upon when coordinated with individual professional advice.

© 2018 Schneider Downs. All rights-reserved. All content on this site is property of Schneider Downs unless otherwise noted and should not be used without written permission.

comments