Section 110 of the current Internal Revenue Code (IRC) provides an interesting opportunity for commercial tenants and landlords alike. Essentially Section 110, in certain instances, allows commercial tenants to make improvements to their leased workspace with the benefit of not having to recognize income for any cash payments or rent reductions that are expressly identified in the lease as qualified Section 110 allowances. Additionally, under a qualified Section 110 provision, the landlord will be treated as the owner of the constructed improvements and entitled to depreciation deductions as nonresidential real estate.
The purpose of this tax provision is to provide a set of rules for certain construction allowances, in which the tax reporting and treatment will be consistent between the lessor and lessee. It’s important to understand the nuances of Section 110 that determine whether such improvements qualify. Qualified property is nonresidential real estate which is part of, or present at, “retail space,” which property reverts to the lessor at the termination of the lease. The term of the lease must be 15 years or less, applying certain rules.
For most commercial landlords and their tenants, it can be overwhelming to understand how and when it’s appropriate to take advantage of Section 110. If you find that you’re uncertain as to whether your situation qualifies, don’t let this be the reason you forfeit this potential tax break altogether. When used properly, Section 110 can offer a huge benefit to both parties, allowing tenants to enjoy an upgraded, functional workspace, and allowing landlords the ability to improve their commercial property.
Take a moment to answer these questions to determine if your property might qualify under Section 110. To help us answer, we’ve enlisted the expertise of Jim Holland, Certified Public Accountant (CPA) to offer insight into qualifying for this tax deduction. *It’s important to keep in mind that these are simplified questions and answers. More details may be necessary to fully assess your situation.
Is my space considered “retail?”
If you leased, occupied or use space in your trade of selling tangible personal property (i.e. products or goods) or services to the general public, this is considered retail space. You qualify!
Am I in a short-term lease?
If your lease, with extensions, is not greater than 15 years in length this is considered a short-term lease. You qualify!
Am I constructing qualified long-term real property for use in my trade or business?
If you construct nonresidential improvements (sec 1250 property vs. sec 1245 property) which revert to the lessor (i.e. landlord or person leasing you the space) at termination of the lease, the answer to this question is yes. You qualify! A note of caution: if the lessor chooses to use a cost-segregation study to reallocate the costs, a different language must be used in the lease agreement.
Who will ultimately own the improvements to the property?
To adhere to the requirements under Section 110, your lease must specifically indicate that the lessor retains ownership of all improvements to the property. In this case…you qualify!
Do I have an official agreement between the tenant and landlord?
If you have obtained a signed agreement, before payment or before the reduction in rent begins, from the lessor to lessee…you qualify!
Will the allowance be expended in the tax year it is received?
If the full amount of your construction allowance is expended within 8 and 1/2 months after the close of the tax year…you qualify!
Will both the landlord and the tenant disclose this information with their tax returns?
In order to fulfill this requirement, you must disclose both the landlord and tenants names, addresses, employer IDs, location, and amount reported on both lessee and lessor tax returns. In doing so…you qualify!
Does the Safe-Harbor Exclusion apply?
If you have met all of the above requirements, the safe-harbor exclusion applies to your situation. You qualify!
As you can see, Section 110 provides a valuable opportunity for commercial tenants and landlords to improve their spaces while each receiving a benefit for doing so. If you meet the requirements, and it makes sense for your situation, taking advantage of the Section 110 tax breaks could open up new possibilities to create the commercial space you’ve dream about having! The most important thing to keep in mind is that you must be aware of the requirements to qualify under Section 110 in order to receive the maximum benefit. Speak to a professional advisor before entering any contract or commitment.
*General Disclaimer: These are simplified answers and your situation may be more complicated. This document is for general information purposes only, and should not be used as a substitute for consultation with professional advisors.
