Why Leasehold Land is Depreciated

Why Leasehold Land

Leasehold land is the land under a rental contract or tenancy agreement, where the property owner (landlord) rents out space to a tenant for use in a business or trade. Often, there are necessary improvements to the space to meet the needs of the tenant and improve the marketability of the property.

When the lease expires, a landlord can sell the Leasehold Services land to a purchaser and depreciate the asset over its useful life. This tax result is subject to negotiation and can be advantageous to the seller-landlord.

There are several reasons why leasehold land is depreciated and it has been subject to changes in recent tax law that have streamlined its application and made it more profitable for both tenants and lessors. These changes include the enactment of a 15-year recovery period for qualified leasehold improvement property placed into service after October 21, 2004 and a reduction in the depreciation rate for qualifying QLHI to 24 years from 39.

Why Leasehold Land is Depreciated

The most important factor in determining the appropriate depreciation treatment for leasehold improvements is the lease term. This is determined by the tenant’s expectation that the asset will be used in the future.

In addition, the remaining term of the lease can be extended if this is reasonable and foreseeable.

This means that the leasehold land is depreciated over the lesser of its useful life or the remaining tenure of the lease or an extended term if it has a reasonably certain future use, such as the potential sale of the property by the landlord.

Leasehold improvements are also depreciated over their useful life if the lease term is long enough that it is likely that the asset will be used by the tenant in the future or if the lessee has a good faith belief that they will be able to obtain the assets at the end of the lease.

Section 179 of the IRS tax code provides a bonus deduction for companies on certain assets, such as tangible property and qualified leasehold improvement property. Qualified leasehold improvement property is generally nonresidential real estate or residential real estate that has been modified to increase its value, but it can be any type of leasehold property.

SS179 and bonus depreciation can be valuable for businesses, as they free up cash to invest in their business operations or allow them to purchase property without the capitalization and depreciation that is often required. However, the benefits are largely intangible and a company’s income statement may be affected by whether it chooses to depreciate or amortize the asset.

The most important reason that leasehold improvements are depreciated over their useful life is that the IRS believes that a dollar today is worth more than a dollar next year. In addition, depreciation is more beneficial to a company than it is to an individual because the company can reinvest this depreciation and make more money in the future.