to be spent improving real property. In
this instance, the treatment by ABC
and XYZ should still be the same,
but because there could be an issue
under examination as to whether the
purpose requirement was met, an
ancillary agreement should be drawn
up to cover this point.
Any portion of the allowance that the
tenant does not use within eight and
a half months after the close of the
tax year in which it was received, or
that the tenant does not apply as a
rent reduction — including amounts
used to acquire Section 1245 property — will not be included under
Section 110 and will be recognized
as gross income.
Example 3. Again, using the same
scenario as in examples 1 and 2,
suppose that ABC uses the entirety of
its allowance on qualifying properties
by the end of the 2016 tax year, but
only spends $650,000 by September
15, 2016 — eight and a half months
after the year in which the proceeds
were received. In this case, ABC
would recognize $350,000 of gross
income on its 2016 federal income
tax return, as this remainder of the
allowance no longer qualifies under
Section 110. Tenants should be
aware of this clause and should ensure that intended improvements are
made within the proper timeframe.
Section 110 requires both tenant
and landlord to attach a statement to
their timely filed federal income tax
returns, including extensions, generally providing details of the parties to
the lease agreement and the allowance. Given the detailed information
required in the statement, tenants
should request this from the landlord
at the time the agreement is signed. n
By Jeffrey J. Schragg, partner, BDO USA LLP
What Are Qualified Improvements?
A landlord may be entitled to use the shorter life of 15 years
(rather than 39 years) for some leasehold improvements they
are required to depreciate under Section 110. Improvements to
building interiors are considered qualified leasehold improvements if all three of the following conditions are met:
1) The landlord and tenant are not related parties.
2) The leased space is occupied exclusively by the tenant.
3) The building has been in service for more than three years.
In this case, the TI allowance could not be used to:
• Enlarge the building.
• Install an elevator or escalator.
• Construct a structural component in a common area.
• Alter the internal structural framework. n