Here’s a common year-end tax question: Should you conduct a Cost Segregation Study on a Tenant Improvement? To answer that, let’s first provide some definitions:

TI: A Tenant Improvement is an interior build-out or modification made to a leased space by, or for, a tenant. This includes such things as partitions, open ceilings, finishes, lighting, cabinetry, plumbing, and signage.

QIP: Under §168(e)(6), for nonresidential real property, “Qualified Improvement Property” is any improvement made by the taxpayer to the interior portion of a building, if the improvement is placed in service after the building was first placed into service.

So, most TI qualifies as QIP and would be eligible for a 15-year depreciation class plus bonus depreciation, and would be a good candidate for a Cost Segregation Study. However, there are a few things to note:

• In a lease, sometimes the landlord pays for the TI work or gives a tenant allowance. In other cases the tenant pays directly. Whomever owns the improvements is who can depreciate them.
• Not every TI qualifies as QIP. The improvements must be interior, non-structural, and not part of the building’s shell, internal structural framework, or enlargements.
• QIP must be placed in service after the building’s initial in-service date to qualify. If the TI is part of the original building shell, it would not qualify.
• The bonus depreciation eligibility depends on the tax year the improvement is placed in service (i.e. the year in which the internal space is ready).

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COST SEGREGATION EXAMPLE

ON A TENANT IMPROVEMENT

Building basis: $4,366,717

Estimated reclass: $4,277,198

Bonus depreciation: $4,277,198

After tax next present value savings: $1,336,550

Estimated first year tax savings: $1,922,683

Total five-year tax savings: $1,725,275