Real Estate
MAY 2002
Congress Allows Additional Depreciation Deduction for Qualified
Leasehold Improvements Made in the Wake of September 11th
President Bush recently signed into law H.R. 3090, titled
the “Job Creation and Worker Assistance Act of 2002”
(the “Act”).1 The Act provides that certain qualified
improvements to nonresidential real property made between September 11, 2001 and September 11, 2004 are
eligible for an immediate 30% one-time depreciation
deduction.
Under Section 168 of the Internal Revenue Code of 1986,
as amended (the “Code”), the applicable recovery period for nonresidential real property, including certain
improvements thereto, is 39 years.
Example 1: Under the Code (as in effect prior to
the Act), if a taxpayer put real property with an
adjusted basis of $100,000 into service in year 1,
the taxpayer generally would have been allowed a
depreciation deduction on the property equal to
$2,564.10 per year for years 1 through 39 (i.e.,
$100,000/39) (assuming straight line depreciation), subject to the application of the mid-month
convention. This would give the taxpayer a total
deduction in year 1 of $2,564.10, subject to the
application of the mid-month convention.
THE ADDITIONAL DEPRECIATION DEDUCTION
Under the Act, a taxpayer is allowed to deduct 30% of the
adjusted basis of Qualified Property (defined below) in
the first tax year in which the Qualified Property is placed
into service, in addition to the depreciation deduction
otherwise allowed under the Code. The taxpayer is then
required to subtract the 30% deducted under this provi-
sion from the adjusted basis of the Qualified Property.
The taxpayer may then calculate, based on that reduced
adjusted basis, the amount of the depreciation deduction
allowable for that tax year and subsequent tax years in
accordance with Code Section 168.2
Example 2:Under the Act, if a taxpayer put Qualified Property with a 39-year recovery period and
an adjusted basis of $100,000 into service in year
1, the taxpayer would be allowed an immediate
depreciation deduction of $30,000 (i.e., $100,000
x .30) subject to the application of the mid-month
convention, leaving the adjusted basis of the property equal to $70,000. The taxpayer would then
be allowed an additional depreciation deduction
of $1,794.87 in year 1 and in years 2 through 39
(i.e., $70,000/39) (assuming straight line depreciation). This would give the taxpayer a total
depreciation deduction in year 1 of $31,794.87.
This is an increase of $29,230.77 (1,140%) over
the depreciation deduction allowed under the prior
law as illustrated in Example 1.
QUALIFIED PROPERTY
Qualified Property includes: (1) property to which Code
Section 168 applies that has a recovery period of 20
years or less; (2) certain computer software; (3) water
utility property; and (4) qualified leasehold improvement property (“QLIP”) (collectively, “Qualified
Property”).
Kirkpatrick & Lockhart LLP
The original use of Qualified Property must commence
with the taxpayer after September 10, 2001, and such
property must be:
(1) acquired by the taxpayer either:
(a) between September 11, 2001 and September
11, 2004, but not pursuant to a written binding
contract in effect before September 11, 2001;
or
(b) pursuant to a written binding contract entered
into between September 11, 2001 and September 11, 2004; and
(2) placed into service:
WHAT IS NOT QUALIFIED
LEASEHOLD IMPROVEMENT PROPERTY?
QLIP does not include improvements attributable to: (1)
the enlargement of a building; (2) elevators or escalators;
(3) any structural component benefiting a common area;
or (4) the internal structural framework of the building.7
EXCEPTIONS
The additional depreciation deduction allowed by the Act
is not available for: (1) property to which the alternative
depreciation system under Code Section 168(g) applies;
or (2) Qualified New York Liberty Zone Leasehold Improvement Property (as defined in Code Section
1400L(c)(2)). Furthermore, a taxpayer may elect out of the
application of the additional depreciation deduction.
(a) before January 1, 2005; or
CONCLUSION
(b) before January 1, 2006, if the property has a
recovery period of at least 10 years, and
(i) the estimated production period of the property exceeds 2 years, or
(ii) the property has an estimated production
period exceeding 1 year and the cost thereof
exceeds $1,000,000.3
Additionally, Qualified Property includes property that
the taxpayer manufactures, constructs or produces for
the taxpayer’s own use, if the taxpayer begins such manufacture, construction or production between September
11, 2001 and September 11, 2004.4
WHAT IS QUALIFIED
LEASEHOLD IMPROVEMENT PROPERTY?
QLIP is defined under the Act as an improvement to the
interior portion of a building which is nonresidential
real property that is: (1) made by the lessee or lessor
pursuant to a lease (as defined in Code Section 168 (h)(7)),
or a commitment to enter into a lease;5 (2) made to a
portion of the real property occupied exclusively by the
lessee; and (3) placed into service more than three years
after the date the building was first put into service.6
While the expenditure of cash resources to make qualified improvements may not be suited to all taxpayers,
the Act provides landlords and tenants of nonresidential
real property who are considering making qualified improvements to their leasehold estates a substantial
incentive for making such improvements before September 11, 2004 (subject to certain extensions). Under the
Act, landlords and tenants making qualified improvements before September 11, 2004 will be allowed a
deduction of 30% of the cost of such improvements from
their federal gross income for the year the improvements
are placed in service, in addition to the deduction for
such improvements otherwise allowed for that tax year.
As illustrated in Examples 1 and 2 above, making such
improvements may provide the improving party an increased deduction of 1,140% of the cost of such
improvements.
If you are interested in learning more about the QLIP
depreciation deduction or have questions concerning
the QLIP depreciation deduction, please contact Pierce
Richardson at prichardson@kl.com or 412.355.6786, or
Matthew Fearing at mfearing@kl.com or 412.355.6305.
PIERCE RICHARDSON
412.355.6786
prichardson@kl.com
MATTHEW FEARING
412.355.6305
mfearing@kl.com
2
KIRKPATRICK & LOCKHART LLP REAL ESTATE ALERT
If you have any questions on this Alert or any other real estate property matter, please contact:
Paul C. Bauer
Howard A. Levine
Stanley V. Ragalevsky
Franklin G. Stearns
Boston
Boston
Boston
Boston
617.951.9247
617.951.9290
617.951.9203
617.951.9275
pbauer@kl.com
hlevine@kl.com
sragalevsky@kl.com
fstearns@kl.com
Michael J. Butler
Julie E. Lennon
Dallas
Dallas
214.939.4941
214.939.4920
mbutler@kl.com
jlennon@kl.com
R. Timothy Weston
Harrisburg
717.231.4504
tweston@kl.com
William J. Bernfeld
Los Angeles
310.552.5014
wbernfeld@kl.com
Daniel A. Casey
Miami
305.539.3324
dcasey@kl.com
John M. Marmora
Newark
973.848.4016
jmarmora@kl.com
Elwood F. Collins
New York
212.536.4005
ecollins@kl.com
Steven J. Adelkoff
David H. Ehrenwerth
Donald A. Kortlandt
Blaine A. Lamperski
David J. Lehman
Pierce Richardson
Pittsburgh
Pittsburgh
Pittsburgh
Pittsburgh
Pittsburgh
Pittsburgh
412.355.6325
412.355.6532
412.355.6546
412.355.8309
412.355.6738
412.355.6786
sadelkoff@kl.com
dehrenwerth@kl.com
dkortlandt@kl.com
blamperski@kl.com
dlehman@kl.com
prichardson@kl.com
Peter W. Sheats
San Francisco
415.249.1030
psheats@kl.com
Thomas F. Cooney, III
Carol M. Tomaszczuk
Washington
Washington
202.778.9076
202.778.9206
tcooney@kl.com
ctomaszczuk@kl.com
ENDNOTES
1
See:http://frwebgate.access.gpo.gov/cgi-bin/
getdoc.cgi?dbname=107_cong_bills&docid=f:h3090enr.txt.pdf.
2 Code § 168(k)(1)(A) and (B).
3 Code § 168(k)(2)(A) and (B). The production periods
provided in Sections II.2(a)(i) and (ii) hereof are set forth
in Code § 263A(f)(1)(B)(ii) and (iii).
NOTE: If a person places property into service after September
11, 2001, and the property is sold by such person and then
leased back by the seller (i.e., a sale-leaseback) within
3 months of the date the property was originally placed
into service, the earliest date on which the property can be
deemed to have been put into service, for purposes of the
Act, will be the first date such property is used under the
leaseback. Code § 168(k)(2)(D)(ii). For property put into
service after September 11, 2004, but which satisfies the
requirements of subsection (2) above, only the adjusted
MAY 2002
basis of the property attributable to the manufacture,
construction or production of the property as of September
11, 2004 is eligible for the additional depreciation
deduction. Code § 168(k)(2)(B)(ii).
4 Code § 168(k)(2)(D)(i).
5 A lease between related persons is not considered a lease
under the Act, and therefore, any improvements made under
such an ostensible “lease” cannot be QLIP. Related persons,
for the purposes of the Act, include members of an affiliated
group (as defined in Code Section 1504) and persons having
a relationship described in Code Section 267(b), however,
the “80%” provision of Section 267(b) shall be substituted
with “50%” for the purposes of the Act.
Code § 168(k)(3)(C)(ii).
6 Code § 168(k)(3)(A).
7 Code § 168(k)(3)(B).
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© 2002 KIRKPATRICK & LOCKHART LLP.
ALL RIGHTS RESERVED.