Expensing Costs of Qualified Real Property Improvements

Expensing costs of qualified real property improvements. The cost of updating and refurbishing a restaurant, retail store or other leasehold property may be fully deductible in 2011, 2012, or 2013 under expanded expensing rules that became law in October 2010. For these years, this expensing prohibition on real property improvements is lifted for improvements to qualified restaurant property, retail property or qualified leasehold property.

Qualifying property. The property must fall within one of these three types of "qualified real property:

• Qualified restaurant property. A building, or an improvement to a building, is qualified restaurant property if more than half of its square footage is devoted to the preparation of and on-premises seating for eating prepared meals. Qualified restaurant property can include a new building, not merely improvements to an existing structure as required for retail and leasehold property.
• Qualified retail improvement property. Improvements made to the interior of a building that is more than three years old and is used as a retail store that is open to the general public may also qualify for the expensing election. But improvements that enlarge the building, add an elevator or escalator, relate to structural components that benefit a common area, or affect the internal framework of the building do not qualify.
• Qualified leasehold improvement property. An improvement, made under the terms of a lease, to the interior of a nonresidential building that is at least three years old and that will be occupied solely by the lessee (or sublessee), may be considered qualified leasehold improvement property. As with retail property, improvements that enlarge the building, add an elevator or escalator, relate to structural components that benefit a common area or affect the internal framework of the building cannot qualify.

Special dollar limitation. In 2013, you can expense up to $500,000 of the costs of business property you purchase and start to use in those years. However, the amount of qualified real property purchases that can be expensed (deducted) is limited $250,000. This means that, if all the requirements are met, you can expense up to $250,000 of expenses that fall within the limitation of Qualified Real Property and still expense other purchases, up to the $500,000 limitation.

For 2013, few small businesses will need to worry about the phase-out of the maximum dollar amount because of the cost of the assets purchased: the new law increases the dollar-for-dollar phase-out threshold to $2,000,000.

Example During 2013, Anne, a restaurant owner, purchased Code Sec. 179-eligible equipment costing $100,000. She also completely refurbished the dining area of the restaurant, which cost $300,000. These were her only asset purchases, and the taxable income limitation (discussed below) does not apply. The maximum section 179 deduction she can claim for 2012 is $350,000 ($100,000 with respect to the equipment and $250,000 with respect to the qualifying leasehold improvements).

Special carryover rules. There is a stricter rule on carryovers for amounts claimed for qualified real property: They can only be carried to a year for which they could be claimed. That means an expense that cannot be fully used up in 2013 (including any amounts carried over from 2010, 2011, and 2012), as of this writing, will be lost as an expense deduction. The cost-basis of the property will be adjusted to include the unused amount, which will be deducted over time through depreciation.

Example In 2012, Joe, a store owner, renovated his entire store. The cost of the renovation was $150,000, and all of the expenses qualify for the deduction. Joe's total taxable income was $50,000. As a result, Joe can only deduct $50,000 of the expenses on his 2012 tax return; the remaining $100,000 is carried to 2013. In 2013, his taxable income was $125,000. The remaining amount is deductible on Joe's 2013 tax return. However, if his income was only $75,000, then $25,000 of the cost of the renovation would need to be deducted via depreciation.

Warning If, in any year after the year you claimed the Section 179 expense deduction, you either sell the property or stop using it more than 50 percent in your business, you may have to recapture or "give back" part of the tax benefits that you previously claimed